Understanding the New Lump Sum & Death Benefit Limits

Background

When the changes were initially unveiled, there was a focus on restricting tax-free cash to £268,275, which is 25% of the current Lifetime Allowance (LTA). However, there was little detail provided about the treatment of other lump sums, particularly those pertaining to death benefits. This ambiguity sparked headlines, with some suggesting the possibility of an unlimited Inheritance Tax (IHT) shelter.

The Draft Legislation

As we move forward, the draft legislation outlines the abolition of the Lifetime Allowance, effective from 6th April 2024. In its place, a new lump sum and death benefit limit will be established, set at the previous LTA level.

Let’s take a closer look at how the new legislation might affect you:

1. Taking Benefits: Upon taking benefits, the tax-free cash or pension commencement lump sum (PCLS) will be limited to £268,275.
2. Tax-Free Lump Sum Benefits on Death under the age of 75: In the unfortunate event of death before reaching the age of 75, the tax-free lump sum benefit will be limited to £1,073,100, minus any PCLS taken.

An Illustrative Scenario

To better understand the impact of these changes, let’s walk through an example:

Imagine someone under 75 takes benefits from their pension with a fund valued at £1,073,100. They decide to take the maximum PCLS of £268,275. The next day, tragedy strikes, and the individual passes away, leaving the fund now valued at £804,825. In this scenario, the beneficiaries can receive the remaining fund as a tax-free lump sum.

However, if the fund exceeds £804,825, any amount above this threshold will be subject to taxation at the beneficiary’s marginal rate.

Unanswered Questions and Final Advice

Despite the clarity provided by the draft legislation, there are still some unanswered questions. For instance, there is no mention of beneficiary drawdown, leaving room for uncertainty about its future. Additionally, as this legislation is still in the draft phase, it may undergo further changes before implementation.

In practice, once the legislation is finalised, seeking advice tailored to each individual’s circumstances will be crucial. If you have valid pension protection in place your tax-free limits may be higher than those given above. For those with substantial pension funds, a review of their situation will be highly recommended to navigate these changes effectively.

In conclusion, the new pension legislation brings forth both opportunities and challenges. Understanding the limits on tax-free cash and lump sum death benefits will be crucial in maximising your pension planning. As we await the finalisation of the legislation, keeping an eye on updates and consulting with your financial planner will be vital in making informed decisions about your retirement funds.

Remember, knowledge is power, and being well-informed will allow you to make the best choices for your financial future.