Transitional Pension Tax-Free Cash: Key Changes and Impact

Withdrawing a transitional pension tax-free cash lump sum is uncommon in most global pension systems. However, in the UK, this has been available since The Finance Act of 1976. The process, though beneficial, can be complex, especially with changing regulations.

This rule permitted individuals to withdraw up to 25% of their pension savings tax-free, referred to as a pension commencement lump sum. However, in 2006, the government introduced restrictions related to the then Lifetime Allowance (LTA). The relevant benefit crystallisation event now impacts the amount of tax-free cash.

For more information on planning retirement ages, check out What is the Best Age to Retire?.

Abolition of the Lifetime Allowance (LTA) in April 2024

The LTA acted as a cap on pension savings, allowing savers to avoid additional tax charges if they remained within the limit. This cap remained frozen at £1.073m for several years.

In April 2024, the government abolished the Lifetime Allowance (LTA), scrapping it entirely. This change means that scheme administrators no longer need to track pension savings against the LTA.

However, uncrystallised funds pension lump sums remain subject to different rules.

Although the LTA has been abolished, the 25% tax-free cash limit remains in effect. This tax-free cash limit is now split into two allowances: the Lump Sum Allowance, set at £268,275 (25% of the old LTA limit), and the Lump Sum and Death Benefit Allowance, capped at £1,073,100 (equivalent to the old LTA limit).

From now on, taking a tax-free lump sum from a pension scheme will be tested against these limits. If the limit is exceeded, it will be classified as an unauthorised payment and incur additional tax charges.

Transitional Tax-Free Cash

Individuals who accessed pension benefits before 6th April 2024 but still have unused pension funds should evaluate their circumstances carefully, as transitional rules will determine how the remaining tax-free cash limits are calculated. This is particularly relevant when considering the pension commencement excess lump sum. For advice on retiring on your own terms, see Retirement Planning Advice – Retire on Your Own Terms.

The default method assumes that 25% of the total LTA used before 6th April 2024 was withdrawn as a tax-free lump sum, regardless of the actual amount taken. It also re-values the amounts based on the final LTA, rather than the LTA at the time of withdrawal. This revaluation affects the defined benefit lump sum and could potentially increase liabilities for many. We have found that this default method can significantly disadvantage many people.

Alternatively, individuals can apply for a Transitional Tax-Free Amount Certificate (TTFAC), which gives a more accurate representation of the amount actually taken. The standard transitional calculation might not be favourable, so it is crucial to apply for a transitional certificate cautiously. Once issued, a TTFAC is binding and cannot be reversed, even if it leads to a less favourable outcome compared to the default method. This makes it a crucial decision that requires careful evaluation.

The ability to take a lump sum without paying tax is a significant financial advantage for retirement planning.

Failing to secure transitional protections or misunderstanding how the rules apply could result in unexpected tax liabilities.

Given the complexity and evolving nature of these rules, professional advice is essential to optimise retirement income while ensuring compliance with tax regulations, especially for retirement tax planning in the UK.

A financial adviser can help ensure you maximise the tax advantages available. Contact us for expert advice—we focus on maximising your tax-free cash, reducing taxes, and helping you secure a comfortable retirement.

For more detailed guidance, visit our I’m Retiring page or our I Need Help with My Pension page.