In April 2023, former Chancellor Jeremy Hunt announced in his Spring Budget that the Lifetime Allowance (LTA) would be abolished, a decision that the current Labour government confirmed. This represented a significant shift in the UK's pension landscape, particularly for individuals with substantial pension savings.
But two new allowances have now taken the place of the LTA:
- The Lump Sum Allowance (LSA)
- The Lump Sum Death Benefit Allowance (LSDBA)
Here’s what they mean for you – and why good planning is more important than ever.
A pension is a long-term investment and funds are not normally accessible until 55 (rising to 57 from April 2028). When investing via a pension, your capital is at risk. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
Farewell to the Lifetime Allowance
First, a reminder of what the Lifetime Allowance was:
- The LTA was the maximum amount you could build up in your pension without potentially being subject to extra tax. It peaked at £1.8 million in 2010 but was gradually reduced over the years, eventually settling at £1,073,100 before its abolition.
- If your pension exceeded this limit when you accessed it or at certain other trigger points (including reaching age 75), the excess was subject to a tax charge:
- 55% if taken as a lump sum
- 25% if taken as income (in addition to income tax)
This created an effective 'ceiling' on pension savings, with many high earners concerned about exceeding the allowance and facing punitive tax charges.
The New Pension Landscape
While the LTA has been abolished, it has been replaced with two new limits:
1. The Lump Sum Allowance (LSA)
The Lump Sum Allowance limits the amount you can take from your pension savings as a tax-free lump sum. It is set at £268,275 (which is 25% of the old LTA of £1,073,100).
This means you can now build up a pension pot well in excess of £1,073,100 without facing additional tax charges, but your tax-free cash remains limited to £268,275.
Some key points:
- Your LSA applies across all of your pension schemes collectively, not individually
- It's reduced by any tax-free cash you've already taken before April 2023
- If you have LTA protection arrangements (like Fixed Protection or Individual Protection), these will increase your LSA accordingly
2. The Lump Sum Death Benefit Allowance (LSDBA)
This new allowance limits how much of your pension can be paid as a lump sum death benefit free of tax. It is also set at £1,073,100, matching the old LTA.
- If you die before age 75, your beneficiaries can receive a lump sum up to this amount tax-free. Any excess will be subject to income tax at the beneficiary's marginal rate.
- If you die after age 75, the entire pension will be subject to income tax at the beneficiary's marginal rate when they withdraw it.
Some key points:
- Most notably, it only applies to lump sums, not to beneficiary drawdown. This gives rise to some strategic planning opportunities—more on this shortly
- Each person has their own LSDBA – it’s not shared between beneficiaries
- If your pension was already tested against the LTA during your lifetime, this reduces your LSDBA
- Unused LSDBA can’t be passed on to your spouse like the inheritance tax allowance can.
Beneficiary Drawdown vs Lump Sum
If your loved ones inherit your pension, they will typically have two choices:
- Take a lump sum (a one-off payment)
- Use beneficiary drawdown (leave the money in a pension and withdraw gradually)
If there is one thing to take away from this blog, it is this: the Lump Sum Death Benefit Allowance (LSDBA) – currently £1,073,100 – only applies if the money is taken as a single lump sum. If your beneficiaries choose the drawdown route, the full pot may be available tax-free, especially if the previous policyholder died before age 75.
Here’s a worked example:
Worked Example
Let’s say Ben, age 70, dies with a pension worth £1.5 million that he hasn’t yet accessed:
Lump sum route:
If Ben’s beneficiaries choose to take the entire funds as a single lump-sum:
- The first £1,073,100 can be taken tax-free (thanks to the LSDBA)
- The remaining £426,900 would be taxed
- Assuming this is subject entirely to 45% income tax (additional rate), they’d pay £192,105 in tax on that extra amount, for net proceeds of £1,307,895.
Drawdown route:
Alternatively, if they opt for the drawdown route:
- Because Ben died before age 75, the entire £1.5 million can be withdrawn tax-free by first designating the funds to beneficiary’s drawdown
- Even if they took the full amount the next day, no income tax would be due, saving £192,105!
As a side note here, the Minimum Pension Age does not apply on inherited drawdown funds. Say, for example, Ben’s pension is inherited by his 45 year-old daughter, she’d be able to access the money immediately, rather than having to wait until age 57 (MPA), as with her own pension savings.
Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts, and their value depends on the individual circumstances of each investor.
Why This Matters
This example illustrates the importance of understanding your options. The way pension benefits are taken can make a huge difference to the tax paid by your loved ones.
A couple of other important considerations here:
- Your Expression of Wishes form – This tells your pension provider who you’d like to receive your pension. If it’s out of date, your loved ones might not be able to choose drawdown and could be forced to take a lump sum (which could mean more tax).
- Your pension scheme’s rules – Not all pensions allow for drawdown after death. Many older workplace schemes only allow lump sum payments, which could trigger unnecessary tax. If so, consider transferring to a more flexible scheme.
A Word of Caution: Multi-Generational Planning
While drawdown can be a smart move, there are longer-term implications, especially if the pension is passed through several generations.
Here’s an example:
- John dies at 74 and leaves his £1.5 million pension to his wife Helen via drawdown
- Since John died before 75, Mary can access the money tax-free
- But Mary doesn’t need the money, so she leaves it in the pension
- When Mary dies at 80, the pension passes to their children – but now they’ll pay income tax on any withdrawals, because Mary died after 75
- From April 2027, that pension pot could also be subject to inheritance tax, as it may now be counted as part of Mary’s estate
…In this situation, it might have made sense for Mary to withdraw some of the money while it was still tax-free – or for the pension to have gone directly to their children in the first place.
New Pension Rules Coming in 2027
From 6th April 2027, pension savings will form part of your estate for Inheritance Tax (IHT) purposes. Put simply, it will no longer be possible to pass on your pension tax-free to anyone other than your spouse or civil partner.
Double Death Tax
What makes this especially punitive is how it interacts with existing rules, including the LSA and LSDBA which are set to endure.
If someone dies after age 75, their beneficiaries already pay income tax on any pension they inherit. With the new rules, that same pot could first face IHT and then income tax when drawn – a scenario that’s being dubbed the "Double Death Tax".
Our View: Build Pension, Spend Pension
The primary purpose of a pension is to provide income in retirement – and that remains the most effective use of these savings.
Historically, pensions have also been a useful estate planning tool due to their favourable tax treatment. However, with the forthcoming changes, they will become significantly less efficient for passing on wealth to beneficiaries (other than a surviving spouse).
In light of this, it is likely to be more appropriate for most individuals to focus on using their pension funds to support their own retirement lifestyle. If passing on wealth is an important objective, we may need to consider alternative, more tax-efficient strategies as part of a broader financial plan.
Conclusion
The abolition of the Lifetime Allowance has undoubtedly simplified some aspects of pension planning, particularly for higher earners. However, the introduction of the new allowances and the future inclusion of pensions in inheritance tax calculations means that careful planning is still essential.
For those with substantial pension savings, the key considerations now centre around:
- Efficient use of the tax-free lump sum allowance
- Managing income tax on withdrawals
- Legacy planning in light of the significance of age 75
- Being prepared for the inheritance tax changes coming in 2027
If you’ve built up substantial pension savings, a ‘wrong move’ – the wrong person inheriting your pension, choosing a lump sum when drawdown is an option, or keeping a rigid, outdated scheme – could cost your family tens or even hundreds of thousands in unnecessary tax.
If in doubt, get advice.
Happy Thursday!
Kind regards,
George
Important Disclaimer
This blog is for general information only and is intended for retail clients. It does not constitute financial or tax advice, nor is it an offer to buy or sell any specific investment. Since I don’t know your personal financial situation, you should not rely on this content as tailored advice. While we aim to provide accurate and up-to-date information, we cannot guarantee that all
