Lifetime Allowance, LSA & Tax-Free Cash

The Lifetime Allowance (LTA) was removed in April 2024 and was replaced by two new limits that determine how much tax-free cash you can take and how pension benefits are treated when you die.

The Lifetime Allowance was a government-imposed limit on the total value of pension benefits you could build up without incurring an additional tax charge. It applied to the combined value of all your pension savings, including both defined benefit (final salary) and defined contribution pensions.

Before it was removed in April 2024, the pension lifetime allowance was set at £1,073,100. If your pension benefits exceeded this threshold, you could face tax charges of up to 55% on the excess, depending on how the benefits were taken.

The aim was to limit the tax advantages of pension saving for high earners. However, over time, more people were affected by it, including those who had enjoyed steady investment growth or long careers.

The Lifetime Allowance was replaced by two new measures introduced by HMRC – the Lump Sum Allowance (LSA) and the Lump Sum & Death Benefit Allowance (LSDBA). From April 2024, these two allowances determined how much of your pension could be paid tax-free:

Lump Sum Allowance (LSA)

The Lump Sum Allowance caps the total amount of tax-free cash you can take from your pension funds during your lifetime. The standard limit is £268,275, which is 25% of the previous LTA.

Lump Sum & Death Benefit Allowance (LSDBA)

Lump Sum & Death Benefit Allowance applies when benefits are paid out on death before age 75. The limit is £1,073,100 (like the old LTA) and controls how much of those payments can be made tax-free to beneficiaries.

Both limits work together to maintain fairness while removing the tax charges that previously applied.

How these caps work in practice

Under the new system, when you take benefits from your pension, the amount of tax-free cash you withdraw is deducted from your Lump Sum Allowance. Once you’ve reached that limit, any further withdrawals will be taxed as income.

Similarly, if you die before age 75, the Lump Sum & Death Benefit Allowance ensures your beneficiaries can receive payments up to that limit tax-free. Anything above that amount may be taxable at their marginal rate.

Example scenarios

Example 1: Taking a standard tax-free lump sum
Sarah has a £800,000 pension pot. She decides to take 25% (£200,000) as tax-free cash. That amount is deducted from her Lump Sum Allowance, leaving £68,275 available if she accesses another pension later.

Example 2: Exceeding the Lump Sum Allowance
John has multiple pensions and has already taken £268,275 tax-free in total. When he accesses a new pension, he must pay income tax on all withdrawals, as he has reached his Lump Sum Allowance limit.

Example 3: Lump sum on death
Emma dies at age 70 with a £900,000 pension pot. Her beneficiaries can receive this amount tax-free as it’s below the Lump Sum & Death Benefit Allowance of £1,073,100.

The removal of the Lifetime Pension Allowance simplifies retirement planning for most people, but the new rules still bring a few important points to be aware of.

Differences between defined contribution vs defined benefit pensions

Defined contribution (DC) pensions are affected when you withdraw tax-free cash or income, as these payments count towards your Lump Sum Allowance.

Defined benefit (DB) pensions are tested when benefits first come into payment. The value used to calculate your LSA is typically 25% of the scheme’s assessed value.

Complications for those who have already taken benefits

If you accessed your pension before April 2024, transitional calculations apply. HMRC will convert your previously used Lifetime Allowance into equivalent values for the new LSA and LSDBA. Those with LTA protection (e.g. Fixed, Enhanced or Individual Protection) may have higher limits than the standard £268,275.

Common misunderstandings and HMRC clarifications

• You can’t “reset” your Lump Sum Allowance by transferring pensions.
• The 25% rule applies cumulatively across all schemes, not per provider.
• Taking small pots (under £10,000) does not reduce your LSA.
• Death after age 75 is taxed as income for the recipient, regardless of the LSDBA.

The amount of tax-free pension cash you can access depends on your pension scheme and the rules set by your provider. However, in most cases, you can take up to 25% of your defined contribution pension pot tax-free, provided this doesn’t exceed 25% of the Lifetime Allowance.

In some cases, you may have a hidden benefit of protected tax-free pension cash, which means you could be entitled to a higher amount. As part of our service, we check your existing pension plans to make sure that you won’t lose out on any existing benefits by switching.

However, suppose you have a defined benefit pension, commonly known as a final salary pension. In that case, the specific scheme rules will control how much tax-free pension cash you’ll receive and how you can take it.

How to maximise your tax-free entitlement

Maximising your tax-free entitlement is about knowing the limits and using them strategically. With careful planning, you can make the most of your pension tax-free lump sum while preserving your long-term income. For many people, that means deciding whether to take their tax-free cash all at once or gradually through pension drawdown. The right choice depends on factors such as your income needs, other pension savings, and overall tax position.

Planning your withdrawals efficiently helps you stay in control of your income and avoid unnecessary tax complications. Instead of taking your full tax-free lump sum in one go, you can withdraw it in smaller instalments through pension drawdown. This approach spreads your use of the Lump Sum Allowance, helps keep your taxable income within manageable limits, and allows your remaining funds to stay invested for potential growth.

Timing can also make a difference. For example, making your withdrawals at the start of a new tax year may give you more flexibility and reduce the risk of breaching a higher tax band. By combining smart timing with professional advice, you can make your tax-free cash work harder across your entire retirement journey.

Withdrawing too much from your pension in a single tax year can push your income into a higher tax bracket, leaving you with less in your pocket. Spacing withdrawals over several years helps you stay within your personal allowance and control the amount of tax you pay.

It’s also worth considering how your pension withdrawals interact with other income sources, such as the State Pension or part-time work. A coordinated approach ensures you use your allowances efficiently and avoid triggering unwanted charges.

Many people choose to take their tax-free pension cash all at once, withdrawing it upfront before accessing the rest of their pension savings. But this isn’t your only option. You can take your tax-free amount in stages or at a time that better suits your financial plans.

The way you access your tax-free cash depends on the retirement product you use and how much of your pension you choose to draw at one time. For example, if you move your pension into a flexible income drawdown plan, you can take a smaller amount now and leave the rest for later. In this scenario, your remaining pot stays invested, giving it the potential to grow before you take further withdrawals, although it’s also possible for the value to fall.

Here’s how that could look:

Imagine you’ve taken 10% of a £100,000 pension pot as tax-free cash…

The pot now contains £30,000 (or 30%) in crystallised funds, and £60,000 (or 60%) in uncrystallised funds. You invest all of this in a drawdown plan.

Two years into this fictional scenario, you need to access the rest of the tax-free cash: that’s 25% of the uncrystallised portion (£60,000 + any growth). So, how has fund performance affected things?

8% Growth

With 8% growth, the remaining tax-free cash equals £16,200.

So, you’d get an extra £1,200 tax-free cash compared to what you’d have received if you took the full 25% upfront.

-6% growth

With a 6% reduction in fund value, the remaining tax-free cash equals £14,100.

Overall, you’d lose £900 compared to what you’d have received if you took the full 25% tax-free cash upfront.

This figure shows a fictional illustration of the performance of two funds over a two-year period. It’s not intended to be indicative of any fund’s actual performance, but of the effect of performance on future tax-free cash withdrawals. My Pension Expert consider investing to be a long-term strategy, with a view to invest for a minimum of five years. The illustration doesn’t account for charges.

With a drawdown plan, you can choose not to take a lump sum at all. Instead, you can withdraw smaller amounts over time, with 25% of each withdrawal paid tax-free. This approach can help you manage your tax position more smoothly throughout retirement.

With an annuity, however, things work differently. If you don’t take all of your available tax-free cash at the start, it will automatically be included in your annuity payments, and you won’t be able to take a separate lump sum later.

What are the benefits of withdrawing tax-free pension cash?

One key benefit of tax-free pension cash is the ability to withdraw up to 25% of your pension pot without paying any tax. This offers a significant opportunity to access a portion of your retirement savings without reducing your overall funds through taxation.

Whether you choose to take this as a lump sum or in stages, tax-free pension cash can provide a helpful boost to your retirement income or fund other financial goals.

Other benefits include:

• Immediate access to funds
• Increased retirement flexibility
• Ability to plan for future expenses
• No rapid tax impact
• More withdrawal control

Before taking any tax-free cash, it’s important to think about how much you need now and how the rest of your pension can support your future plans. While you’re free to use your tax-free cash however you choose, there may be advantages to leaving some of it invested if you don’t have an immediate need for it. Doing this may enable your pension to grow further, and in most cases, the remaining pot will stay outside your estate for inheritance tax purposes, which can be beneficial for your loved ones.

Depending on your circumstances, taking money out at the wrong time can limit your long-term financial flexibility or reduce the advantages that pensions offer. Some key drawbacks to consider include:

• Reduced future growth – withdrawing too much, too soon can leave less invested, limiting the potential for tax-free investment growth.
• Impact on benefits – large withdrawals may affect eligibility for certain means-tested benefits.
• Loss of tax efficiency – once money leaves your pension, it’s no longer shielded from tax, which may reduce how far your savings stretch over time.

Understanding these drawbacks will help ensure that any withdrawal you make fits into your wider retirement strategy and supports both your immediate needs and long-term financial security.

Understanding how the end of the Lifetime Allowance affects you and how to manage your new Lump Sum Allowance is important so you avoid mistakes that could impact your retirement income.

Why it’s important to consider taking advice

Rules around lifetime pension allowance, transitional protection and tax-free cash are complex. A regulated adviser can help you:

• Check how much of your allowance remains available.
• Maximise your tax-free entitlement without triggering unnecessary charges.
• Combine your defined benefit and defined contribution pensions effectively.

Important information

Tax treatment depends on your individual circumstances and may be subject to change in future. It’s not always possible to change your mind about what you do with your pension. Advice can help you make sure your choices are right for your circumstances.

Frequently Asked Questions