The New Rules of Retirement: Understanding the Lump Sum Allowance
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If you’ve been keeping an eye on your pension savings, you may have come across the term Lump Sum Allowance, especially since the UK government introduced changes to pension tax rules in April 2024. But what does it actually mean, and how does it affect your retirement planning?
A Quick Refresher: What Changed in 2024?
Before April 2024, pension savers had to navigate the Lifetime Allowance (LTA), a cap on the total amount you could build up in your pension pots without facing extra tax charges. That’s now gone.
In its place, the government introduced three new allowances:
Lump Sum Allowance (LSA)
Lump Sum and Death Benefit Allowance (LSDBA)
Overseas Transfer Allowance
This blog focuses on the first: the Lump Sum Allowance.
So, What Is the Lump Sum Allowance?
The Lump Sum Allowance is the total amount of tax-free cash you can take from your pension pots during your lifetime. For most people, this is set at £268,275. This figure is 25% of the old Lifetime Allowance (£1,073,100), which is why it might look familiar.
Why Does It Matter?
When you access your pension, you’re usually entitled to take a portion of it as a tax-free lump sum, often called the Pension Commencement Lump Sum (PCLS). The Lump Sum Allowance limits how much of this tax-free cash you can take across all your pensions.
If you go over the limit, the excess will be taxed as income.
Real-Life Example: Meet Sarah
Sarah is 60 and has three pension pots:
A workplace pension worth £500,000
A personal pension worth £300,000
A small defined benefit pension offering a £30,000 lump sum
She decides to take 25% tax-free cash from her workplace and personal pensions:
£125,000 from the workplace pension
£75,000 from the personal pension
She also receives the £30,000 lump sum from her defined benefit scheme.
Total tax-free cash: £125,000 + £75,000 + £30,000 = £230,000
Sarah is still under the Lump Sum Allowance of £268,275, so she doesn’t pay any tax on these withdrawals.
But if she later accesses another pension and tries to take more tax-free cash, she’ll need to check how much of her allowance remains.
What Counts Towards the Lump Sum Allowance?
The following types of payments count:
Pension Commencement Lump Sums (PCLS) – the tax-free cash you take when you start drawing your pension.
An Uncrystallised Funds Pension Lump Sum (UFPLS) – when you withdraw a lump-sum from your pension which is part-tax free and part taxable. The tax-free element counts towards your allowance
What Doesn’t Count?
Interestingly, small pot lump sums (usually pensions under £10,000) don’t count towards the Lump Sum Allowance. You can take up to three of these from personal pensions and unlimited from occupational pensions.
What If You Had Pension Protection?
If you had Lifetime Allowance protection before April 2024 (like Fixed Protection or Individual Protection), your Lump Sum Allowance might be higher than £268,275.
For example, if your protected Lifetime Allowance was £1.5 million, your Lump Sum Allowance could be £375,000 (25% of £1.5 million).
But you’ll need to provide evidence of this protection when you start drawing your pension.
Planning Ahead
The Lump Sum Allowance adds a new layer of complexity to pension planning. It’s especially important if:
You have multiple pension pots
You’re approaching retirement and want to maximise your tax-free cash
You’ve taken some pension benefits already and plan to take more later
Keeping track of how much of your allowance you’ve used is key. Your pension provider should give you this information, but it’s wise to keep your own records too.
Final Thoughts
The Lump Sum Allowance is a crucial part of the UK’s new pension tax landscape. While it simplifies things in some ways, replacing the Lifetime Allowance, it also requires careful tracking to avoid unexpected tax bills.
If you’re unsure how the rules apply to your situation, especially if you have older pensions or protection in place, it’s worth speaking to a regulated financial adviser to help you make the most of your pension savings while staying within the rules.