Paying into a pension could be an efficient way to save for retirement because you may benefit from employer contributions, and you can receive tax relief on your payments too (subject to limits and being under 75).
Normally, you benefit from 20% tax relief immediately on pension contributions, and you may be able to claim another 20% or 25% if you are a higher- or additional-rate taxpayer.
Over the course of your working life, this tax relief could significantly increase the size of your pension pot, making it easier for you to achieve your dream lifestyle in retirement. However, there are certain rules that may limit the tax benefits of your pensions.
In April 2024, some of these rules changed and it is important that you understand how the new system works so you can make the most of your pensions.
Read on to learn where you stand six months on from key pension changes.
The Lifetime Allowance limited the amount of wealth you could accrue in your pensions without triggering an additional tax charge
One of the most significant changes that came into place was the abolishing of the Lifetime Allowance (LTA).
The LTA was an upper limit to the amount you could accrue in your pensions tax-efficiently and it stood at £1,073,100. This figure may have been higher for you if you had previously applied for LTA protection.
Prior to April 2023, if you had more than £1,073,100 in your pensions, you may have paid an additional tax charge on the excess when you withdrew it or reached age 75. You would have paid tax of:
- 55% on lump sums
- 25% on income, on top of your marginal rate of Income Tax.
However, the previous Conservative government announced that it would remove the LTA charge from April 2023 and abolish the LTA altogether in April 2024.
This may have been welcome news as it might mean you are able to build more wealth in your pensions without triggering an additional tax charge when you come to draw your funds.
3 new allowances replaced the Lifetime Allowance
With the LTA abolished, the government introduced three new pension allowances that control key aspects of your pension wealth. These predominantly relate to the tax you will face on lump sums.
They are the:
1. Lump Sum Allowance
Normally, you can take the first 25% of your pensions as a tax-free pension commencement lump sum. However, the Lump Sum Allowance (LSA) limits the value of the tax-free benefits you can receive to £268,275 in 2024/25. You may have a higher LSA if you had previously applied for some sort of LTA protection or had scheme-specific tax-free cash protection.
Any pension commencement lump sums you take that exceed the LSA will then usually be taxed at your marginal rate of Income Tax.
The tax-free element of certain lump sums will not be deducted from the LSA. This includes:
- Trivial commutation lump sums
- Winding up lump sums
- Small pot lump sums.
It is worth noting that for trivial commutation and winding up lump sums, you must have available allowances to take them. This does not apply to small pots.
2. Lump Sum and Death Benefits Allowance
The Lump Sum and Death Benefits Allowance (LSDBA) is a total limit on the tax-free pension commencement lump sums, and the tax-free element of other lump sums paid during your life or after you pass away. For example, this includes serious ill-health lump sums or death benefits paid to your family.
The LSDBA is £1,073,100 in 2024/25 (again, this may be higher if you had LTA protection). The recipient of any lump sums or death benefits that exceed the LSDBA will pay tax on the surplus. The amount they pay depends on their marginal rate of Income Tax. This does not include death benefits received through beneficiary drawdown.
As before, if you die after age 75, your beneficiaries will have to pay Income Tax at their marginal rate on all benefits. So, there will be no testing against the LSDBA if you pass away over this age limit.
These rules only apply to individuals, and may be different for beneficiaries who are “non-qualifying persons”, such as trusts, personal representatives, or companies.
3. Overseas Transfer Allowance
The Overseas Transfer Allowance (OTA) of £1,073,100 typically applies if you move your pension savings to a new scheme overseas.
You could pay a 25% tax charge on any pension wealth that exceeds the OTA when transferring your savings abroad.
If you have not accessed any of your pensions before April 2024, future withdrawals will be measured against these allowances.
Conversely, if you have accessed your pensions before April 2024, your allowances may be reduced.
It is also worth noting that your allowances may be higher if you previously had LTA protection or scheme-specific tax-free cash.
Your allowances may be different if you accessed your pensions before the abolition of the Lifetime Allowance
One key aspect to be aware of is how you will be affected if you had already accessed your pension savings before the LTA was abolished in April 2024.
Normally, your previous withdrawals are measured against the LTA to determine how much of the allowance you used. Your LSA is then reduced by 25% of this amount.
For instance, imagine you used the full LTA of £1,073,100. Your LSA would be reduced by 25% of this amount. This equates to £268,275, meaning you will not have any of your LSA left.
In comparison, imagine you only used £500,000 of your LTA. In this case, your LSA would be reduced by £125,000, meaning you would have £143,275 left (assuming you did not have LTA protection).
Similar calculations are used to determine how much of your LSDBA you have left.
These scenarios can be quite complex, and it may be difficult to determine how the new allowances affect you. That is why you may benefit from seeking professional guidance to ensure you are drawing from your pensions as tax-efficiently as possible.
You may also benefit from obtaining a “transitional tax-free amount certificate” from your scheme provider. You must do this before any relevant lump sum benefits are taken after 5 April 2024.
You are still affected by the Annual Allowance
While the LTA is abolished, there is still a limit on total tax-efficient contributions you can make to your pension each tax year.
Indeed, despite the abolition of the LTA in April 2024, the Annual Allowance still affects you. This is a limit on the total amount you can contribute to your pensions each tax year without triggering an additional tax charge.
In 2024/25, the Annual Allowance is usually £60,000. You may be able to carry forward unused Annual Allowance from previous tax years. Equally, your allowance may be reduced if your earnings exceed certain thresholds, or you have already flexibly accessed your pension.
Although the Annual Allowance stands at £60,000, you can usually only receive tax relief on pension contributions worth up to 100% of your earnings.
You may need to consider the Annual Allowance when deciding on the most efficient ways to build wealth for retirement.
Get in touch
If you need help understanding how new pension rules could affect you, then please do get in touch with us at DBL Asset Management.
Email enquiries@dbl-am.com or call 01625 529 499 to speak to us today.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pension Regulator.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.
