I have individual protection 2016. I took my public service pension in 2019 with a tax-free lump sum below the current cap of £268,275, which is based on 25% of the current lifetime allowance of £1,073,100.  

I also have an uncrystallised SIPP (with AJ Bell).  In the next financial year, I’m planning to take the tax-free lump sum from my SIPP up to the maximum tax-free allowance cap.   Am I correct to think that my maximum tax-free lump sum is 25% of my IP16 lifetime allowance and not £268,275? 

Marthin

Rachel Vahey, AJ Bell Head of Public Policy, says:

In only a few weeks’ time, the way pensions are taxed is changing. Last March, Jeremy Hunt, the Chancellor, announced the lifetime allowance was being abolished. It has taken a year to sort out the legislation on exactly what will replace it and how the new pension rules will work.

From 6 April 2024, only the lump sums you take from your pension will be tested. Pension savers can take as much income as they want from their pension, but most will only be able to take tax-free lump sums of up to £268,275 during their life. This is called their lump sum allowance (LSA).

Those who applied for lifetime allowance protection, when the lifetime allowance was cut in 2012, 2014 and 2016, are currently entitled to a higher lifetime allowance, and therefore can take a higher amount of tax-free lump sums. These higher allowances will carry into the new regime. For example, someone who applied for individual protection 2016 with a lifetime allowance of £1.2 million will currently be allowed to take up to £300,000 in tax-free lump sums. From 6 April 2024, their lump sum allowance will also be £300,000.

So far so simple, but there are transitional rules to bridge moving from the old set of pension tax rules to the new.

Pension savers’ lump sum allowances will be reduced by whatever tax-free lump sums they have already taken before 6 April 2024. To make life easier this will generally be done by a straightforward calculation assuming that they have taken 25% of the lifetime allowance they have already used up as tax-free lump sums.

In our example above, if the pension saver with the individual protection of £1.2 million had used up 40% of their lifetime allowance, the calculation assumes 25% of that – in other words 10% – was used by taking tax-free lump sums. As 10% of £1.2 million is £120,000, this will be deducted from their lump sum allowance leaving a new amount of £300,000 minus £120,000 or £180,000.

From 6 April 2024, the same pension saver can take tax-free lump sums during their life of up to £180,000. This will be either a pension commencement lump sum (PCLS) or the tax-free part of an ad-hoc lump sum, or an uncrystalised funds pension lump sum to give it it’s full name. The rules for serious ill-health lump sums are more complicated and for another article.

If a pension saver has used up 100% of their lifetime allowance before 6 April 2024, then their lump sum allowance will be zero.

Some people may be concerned the simple transitional calculation gives them an unfair lump sum allowance because they have not taken a quarter of their used-up lifetime allowance as tax-free cash.

If that is the case, they can apply to their pension scheme for a certificate to put them into the correct tax position and give them a higher lump sum allowance. I will explain more about how this process works over the next few weeks.

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