The Lump Sum Allowance (LSA) has replaced the old pensions Lifetime Allowance (LTA) as an important tax consideration when it comes to accessing your retirement savings.

The old LTA was an upper limit on the amount of money you could save into a pension without incurring taxable drawbacks. The limit was set at £1,073,100 – a figure which is still relevant which we will come to shortly.

The LTA differs from the pensions annual contribution allowance which is £60,000 – this is how much you can put into a pension tax-free each year. The LTA was the maximum you could ever put into pension savings in total.

As of this tax year it has now been entirely abolished, although it has in practice been redundant since April 2023 when the principal charge was removed. In its place has been implemented a new Lump Sum Allowance (LSA).

What is the Lump Sum Allowance?

The LSA has replaced the LTA as the main lifetime taxable consideration for pensions savings.

When drawing down your pension you are entitled to a tax-free lump sum. When this tax-free lump sum was initially created it was set at 25% of your overall pot.

With the old LTA set at £1,073,100, this in effect created a maximum tax-free lump sum of £268,275 although this was implicit rather than explicit.

What the Government has done now however is make the lump sum allowance explicit – set at the same amount of £268,275. So now you can take a 25% tax-free lump sum from your pension, but £268,275 is the maximum.

On top of that it has created another allowance, called the lump sum and death benefit allowance (LSDBA) set at £1,073,100. The LSDBA differs in that it is the limit on the tax-free cash available on the death of the pension holder, or if a serious ill-health lump sum is taken under the age of 75.

There is also now an overseas transfer allowance also set at £1,073,100. The overseas transfer allowance is relevant if you intend to transfer your pension abroad.

This can only be done to a qualifying recognised overseas pension scheme (QROPS) and can be refused if your provider does not recognise the receiving entity. If it isn’t a QROPS then you’ll face a 40% tax charge, or the provider may refuse to transfer.

What are the tax implications?

The LSA can be triggered when you drawdown your pension and is potentially very valuable to future retirement planning. However, there are some tax implications to consider.

Anything drawn down from a pension above this lump sum will be classed as income and charged at your marginal rate of income tax. However, small lump sum payments of under £10,000 do not count toward the overall limit.

The LSA has also made a subtle but important change in the way in which pension income will be taxed in the future. This is because by creating an official £268,275 maximum for the LSA, the Government in effect created a new kind of potential fiscal drag boundary.

Fiscal drag is a stealth tax used by the Government in recent times to increase its tax take without raiding marginal rates. In effect – if the Government doesn’t increase the LSA in line with inflation in future years, it means that as pension pots increase in value then the Government will increase its overall tax take on the income from those pots, while the value of the allowance diminishes versus inflation.

You must also keep in mind the money purchase annual allowance (MPAA). This is triggered once you draw down pensions funds and will slash your annual contribution limit from £60,000 to just £10,000. This is however an unchanged aspect of pensions and was relevant before the LTA abolition but is still important to be aware of in the context of lump sums.

What is most important therefore is to plan for the rules in front of you. Pensions are not easy products to navigate even at the best of times, so it is essential to consider using the help of a qualified financial adviser to ensure you make the best choices possible for your retirement.