The LTA replacement regime explained

When the new tax year began on 6 April 2024, the lifetime allowance (LTA) replacement came into force. Like the increases to pension annual allowances, this is good news for clients saving for their retirement. 

This year we have three new allowances and, to be clear, it’s just lump sums that use up these allowances:

• Lump sum allowance (LSA) – this is set at £268,275, which is 25% of the old lifetime allowance. The LSA is used for tax-free payments such as PCLS and the tax-free elements of any Uncrystallised Funds Pension Lump Sum (UFPLS) payments.
• Lump sum and death benefit allowance (LSADBA) – this is set at £1,073,100, the same figure as the old LTA. The LSADBA is used for the following: 
  • PCLS payments and the tax-free elements of UFPLS payments – it differs slightly to the LTA regime because if a client previously took a PCLS payment of £100,000, then they crystallised £400,000 and used £400,000 of their LTA. If the client crystallises £400,000 now, it is just the £100,000 PCLS payment that reduces their LSA and LSADBA.
  • Serious ill health lump sums – where the client is under age 75, has uncrystallised benefits and a diagnosis of less than 12 months to live, they can take pensions from their arrangements up to the limit tax free. This doesn’t often happen because the client would be bringing the money from an IHT-favourable environment into the estate but, if they did, this would use some or all of the allowance.
  • Defined benefit lump sum death benefit (death in service benefits that are written under pensions legislation) and uncrystallised funds lump sum death benefits – previously, these would have been tested against the old LTA but are tested against the LSADBA going forwards.
  • Pension protection lump sum death benefit (LSDB), annuity LSDB, drawdown pension LSDB and flexi-access drawdown LSDB – these are all new as they weren't tested under the LTA if an individual crystallised benefits before age 75. Please note, if a client crystallised benefits before 5 April 2024 and dies after this date, the crystallised benefits are not tested against their LSADBA. 
    
    While these are new tests, the important point to consider is the word ‘lump sum’ – it is only lump sums that are tested against these allowances, which are taxable at the client’s marginal rate if the allowances are exceeded. Please note that Beneficiary Flexi-access Drawdown (BFAD) is excluded, which is a U-turn in terms of the original legislation that was proposed. BFAD remains outside of the testing regime – so, if the client dies before age 75, BFAD is paid tax free whatever the size of the pension arrangement. If the client dies at or after age 75, BFAD is still not tested but is taxable as before on withdrawal only. 
• Overseas Transfer Allowance – this replaces BCE 8 under the old regime (transferring to QROPS - qualifying recognised overseas pension scheme). The starting point is that the allowance is set at the same amount as the LSADBA and so is used when a client transfers benefits to QROPS - qualifying recognised overseas pension scheme. Benefits can be transferred tax free if they are within the allowance but they are taxable at 25% where it has been exceeded (as they would under the old LTA regime).

Lifetime allowance replacement

Three new “lump Sum” allowances

There are a few things to consider with these new allowances: 

• If a client has LTA protection, this increases the numbers. So, if they have Fixed Protection 14 (£1.5 million), they will have a LSADBA of £1.5 million and a LSA of £375,000. Where Enhanced Protection is held, the LSA will be the PCLS figure available to the client on 5 April 2023 while the LSADBA will be the value of uncrystallised funds on 5 April 2024.
• Clients can still apply for FP16 (and IP16) but if they do apply for FP16, they cannot have made contributions since 5 April 2006 and, unlike those who had protection before 15 March 2023, they won’t be able to make contributions without losing the protection. However, for some clients, it could still be worth applying for FP16 in terms of getting higher tax-free death benefits or, perhaps more importantly, higher PCLS payments. The application deadline for IP16 & FP16 is 5 April 2025.
  • The rules I’ve mentioned so far are only for individuals who didn’t take any benefits before April 2024. However, if they did, their allowances will be reduced. The default is that if they used all their LTA under the old regime, they will have no allowances going forwards. If they used some but not all of their allowance, then 25% of the amount of LTA used – either tested against the standard LTA (£1,073,100) or, where applicable, the protected amount – will be deducted from their allowances. This could be detrimental for some individuals – for example, for a DB client who used all their LTA but who only took a scheme pension and no PCLS, the default position will be that they have no lump sum allowance. However, these clients can apply for a ‘transitional tax-free amount certificate’ that overrides the default amount. Importantly though, they must apply for this certificate before they make their first crystallisation after 5 April 2024. So, in my example, if the DB client obtains a certificate, this would reinstate their allowances and full entitlement to PCLS.
• The final minor point relates to individuals who previously would have applied for a higher LTA through pension credits from previously crystallised arrangements, where they’ve been a member of a UK scheme and worked overseas, or who transferred benefits from overseas. Under the old regime, they had five years to make the application. Going forwards, they will still be able to apply for higher allowances in relation to any event that occurred before 6 April 2024, but they only have until 5 April 2025 to do so.

Transitional considerations

So, that wraps up the three new allowances. If you want more help with understanding the rules relating to the LTA replacement, please visit the page Replacement of the lifetime allowance.