Lump Sum Allowance (LSA)
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An in-depth technical guide to the 2024 Lump Sum Allowance (LSA)
An in-depth technical guide to the 2024 Lump Sum Allowance (LSA)
The pension landscape in the UK underwent significant changes in 2024, with the abolition of the Lifetime Allowance (LTA) and the introduction of new allowances, including the Lump Sum Allowance (LSA).
The Lump Sum Allowance (LSA) is a new concept introduced in the UK pension system from 6 April 2024 as part of the 2023 spring budget. It replaces the previous rules governing tax-free cash withdrawals from pension schemes, which were tied to the now abolished Lifetime Allowance.
Key points about the Lump Sum Allowance:
The introduction of the Lump Sum Allowance in 2024 marked a significant shift in the UK pension landscape. Here are the key changes and their implications:
Abolition of the Lifetime Allowance (LTA): The LTA, which previously capped the total amount of pension savings an individual could accumulate without incurring a specific tax charge, was abolished. This removal eliminated the potential for LTA charges on excess funds.
Introduction of the LSA: The LSA was introduced to maintain some control over tax-free cash withdrawals from pensions, ensuring that there’s still a limit on the amount of tax-free cash an individual can receive.
Decoupling from overall pension value: Unlike the LTA, which was based on the total value of an individual’s pension savings, the LSA focuses specifically on tax-free cash withdrawals. This change allows for potentially greater flexibility in pension accumulation.
New calculation methods: The introduction of the LSA necessitated new calculation methods for determining available tax-free cash, particularly for individuals with benefits taken before April 2024.
Impact on transitional protections: Existing protections, such as Fixed Protection and Individual Protection, were adapted to work with the new LSA system, often providing higher LSA limits for protected individuals.
Calculating an individual’s available Lump Sum Allowance can sometimes be complex, specifically for those with pension benefits taken before April 2024. Here’s a detailed look at the calculation methods:
For individuals without any pension benefits taken before April 2024, the calculation is straightforward:
Available LSA = £268,275 - Any tax-free cash taken from 6 April 2024 onwards
By default, the standard calculation method is applied:
Remaining LSA = £268,275 - (25% x LTA used before 6 April 2024)
This method assumes that 25% of the Lifetime Allowance used was taken as tax-free cash, even if this wasn’t the case in reality.
John crystallised £500,000 of his pension in 2020, using up 47.62% of his LTA (when the LTA was £1,073,100).
Calculation:
For some individuals, the standard calculation may not accurately reflect their actual tax-free cash usage. In these cases, they can apply for a Transitional Tax-Free Amount Certificate (TTFAC), which allows for an alternative calculation based on the actual tax-free cash taken.
Remaining LSA = £268,275 - Actual tax-free cash taken before 6 April 2024
View our in-depth resource on Transitional Tax-Free Amount Certificate
While the Lump Sum Allowance focuses on tax-free cash taken during an individual’s lifetime, it’s important to distinguish it from the related Lump Sum and Death Benefit Allowance (LSDBA).
Key differences between LSA and LSDBA:
| Lump Sum Allowance (LSA) | Lump Sum and Death Benefit Allowance (LSDBA) |
|---|---|
| Applies to lump sums taken during lifetime | Includes lifetime lump sums and certain death benefits |
| Standard limit of £268,275 | Standard limit of £1,073,100 |
| Covers PCLS and tax-free element of UFPLS | Also includes serious ill-health lump sums and some death benefits |
The LSDBA provides a broader allowance that encompasses both lifetime lump sums and certain death benefits.
The introduction of the Lump Sum Allowance has implications for individuals who hold various forms of transitional protection. These protections, originally designed to safeguard pension rights when the Lifetime Allowance was introduced and subsequently reduced, have been adapted to work with the new LSA system.
| Protection Type | Impact on LSA |
|---|---|
| Primary Protection | - No registered tax-free cash: LSA = £375,000 - Registered tax-free cash: LSA = registered amount x 1.2 |
| Enhanced Protection | - No registered tax-free cash: LSA = £375,000 - Registered tax-free cash: Capped at amount payable on 5 April 2023 |
| Fixed Protection 2012 | £450,000 |
| Fixed Protection 2014 | £375,000 |
| Fixed Protection 2016 | £312,500 |
| Individual Protection 2014 | LSA = Lower of: - 25% of protected value - £375,000 |
| Individual Protection 2016 | LSA = Lower of: - 25% of protected value - £312,500 |
The introduction of the Lump Sum Allowance has significant implications for members of Defined Benefit (DB) pension schemes.
In DB schemes, tax-free cash is typically provided through one of two methods:
The maximum tax-free cash available through commutation is calculated as follows:
Max TFC = (20 x pension before commutation) / (3 + 20/CF)
Where CF is the commutation factor used by the scheme.
For schemes providing a separate lump sum, the maximum tax-free cash is typically calculated as:
Max TFC = 6.666 x annual pension
Scheme-specific rules: DB schemes may have their own rules limiting tax-free cash, which may be more restrictive than the LSA.
Partial transfers: If a member transfers part of their DB benefits to a DC scheme, this can impact the calculation of available tax-free cash from the remaining DB benefits.
Guaranteed Minimum Pension (GMP): For schemes with GMP, no tax-free cash can be paid from the GMP portion, potentially affecting the overall tax-free cash calculation.
Multiple DB schemes: If a client has benefits in multiple DB schemes, each scheme’s tax-free cash entitlement needs to be considered separately in relation to the overall LSA.
Commutation analysis: Evaluate whether taking the maximum tax-free cash through commutation is beneficial, considering factors like commutation factors and income needs.
TTFAC considerations: For DB scheme members who have already taken benefits, assess whether applying for a TTFAC could be advantageous.
The Lump Sum Allowance also has significant implications for Defined Contribution (DC) pension schemes
In DC schemes, members typically have more flexibility in how they access their pension savings. The main ways of taking tax-free cash are:
Flexible access: DC schemes often allow members to take tax-free cash in stages, which can be advantageous for LSA management.
Partial crystallisation: Members can choose to crystallise only part of their DC pot, potentially preserving LSA for future use.
UFPLS considerations: Each UFPLS payment uses up some of the individual’s LSA, which needs to be tracked carefully.
Phased retirement: Utilising a phased retirement approach can help spread LSA usage over time, potentially maximising tax efficiency.
LSA prioritisation: Consider prioritising tax-free cash withdrawals from DC schemes over DB schemes if a client has both, as DC schemes offer more flexibility.
Investment strategies: Align investment strategies with planned tax-free cash withdrawals to ensure funds are available when needed without compromising long-term growth.
Tax charges: Any lump sum taken in excess of the available LSA will be subject to income tax at the individual’s marginal rate.
Pension Commencement Excess Lump Sum (PCELS): This is a new type of authorised payment introduced to accommodate lump sums that exceed the LSA.
Impact on future withdrawals: Once the LSA is exhausted, future lump sum withdrawals will be fully taxable at marginal rates on the plan owner.
Q: Can the Lump Sum Allowance be carried forward if unused? A: No, the LSA is a lifetime allowance and doesn’t have a carry-forward mechanism.
Q: How does the LSA interact with pension transfers? A: Transfers between registered pension schemes don’t typically impact the LSA, but transfers to QROPS may use up LSA.
Q: How does divorce affect the LSA? A: Pension sharing orders can impact LSA calculations. The recipient of a pension credit will have their own LSA to