So for advisers, this is a technical but high-value area where getting the sequencing right, and understanding the interaction with the Lump Sum and Death Benefit Allowance (LSDBA), is critical.

Here’s a quick overview of how it works, and how to get it right.

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The history

The lump sum allowance (LSA) is generally simple in how it is applied but there is an interesting outcome that can occur for certain individuals that can quite literally mean a difference of thousands of pounds of tax-free cash. It is specifically for those with scheme specific tax-free cash protection.

In the world of the lifetime allowance, when you crystallised a pension, the amount you crystallised reduced your lifetime allowance without reference to the PCLS you received. The benefit therefore for those with scheme specific tax free cash protection (which we will call protected TFC from here on) is that the LTA usage did not look at how much PCLS was actually paid.  

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If you crystallised £173,100 of the LTA in January 2024 for example, you would be using 10% of the LTA whether the PCLS was 25% or more (or none in the case of annuity purchase without PCLS).

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‍The LSA regime

The same is generally true under the LSA when it comes to protected TFC. When you crystallise a pension now, the amount used for LSA purposes is assumed to be 25% of the amount crystallised.  

In our earlier example of £173,100, the LSA will be reduced by £43,275. This breaks a bit with the concept of the LSA which is meant to be based on the amount of cash paid out. Crystallising this pension would then leave £225,000 of PCLS left (£268,275 - £43,275), regardless of how much PCLS you actually got from the £173,100.

This is useful as a single feature, but not the main advantage. The major advantage instead comes from the fact that protected TFC does not need LSA available to even be paid. In other words, protected TFC can be paid if there is the LSA available or not.  

If you have LSA available, the crystallisation of a pension with protected TFC will use 25% of the amount crystallised. If you have no/minimal LSA available, protected TFC will still be paid tax-free.
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Interaction with the LSDBA

Protected TFC does though get counted in full against the LSDBA, and this allowance acts as a real limiter on the amount of PCLS that can be paid out. Given the LSDBA is £1,073,100, it is a high limit. ‍

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Crystallising in the correct order

If your client had a SIPP worth £1.2m and a personal pension worth £300,000 which itself had protected TFC of £170,000, you would have two possible crystallisation paths:

• Crystallise the PP first

• 25% of £300,000 (£75,000) is assumed to have been taken as PCLS

• The standard LSA is reduced by the assumed 25% figure of £75,000 to £193,275

• The LSDBA is reduced by the actual PCLS figure of £170,000 to £903,100

• £773,100 of the SIPP is crystallised to provide the maximum remaining PCLS of £193,275

• £579,825 of the SIPP remains uncrystallised and unable to provide PCLS

• The remaining LSDBA is £709,825

• Total PCLS paid out: £268,275

• Total remaining fund subject to income tax: £1,231,725
  

• Crystallise the SIPP first

• £1,073,100 is crystallised to provide £268,275 PCLS

• £126,900 of the SIPP is uncrystallised

• The LSA is £0

• The LSDBA is £804,825

• The PP can be crystallised in full paying £170,000 PCLS. No LSA is required.

• The LSA is still £0

• The LSDBA is now £634,825

• Total PCLS paid out: £438,275

• Total remaining fund subject to income tax: £1,061,725

As we move toward IHT being assessed as pensions, it is likely that people will take full PCLS from pensions, especially as they near the age 75 double tax problem. As we see from the difference above, taking care of the order when protected TFC is present can mean a significant difference in tax-free cash paid.

The lower LSDBA is not a huge disadvantage as crystallised funds are not tested against the LSDBA. You can also structure any further uncrystallised funds to avoid the LSDBA test by being in pension that can avoid paying out as a lump sum on death.

The only thing to be aware of is the need to have the LSDBA to absorb the PCLS, as this acts as a natural hard limit on the amount that can be taken through this method. If the allowance is lower as a result of prior crystallisations, there may be a limit to how much can be received through this method.  
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Key takeaways:

• Pension crystallisation order matters under the LSA where scheme-specific tax-free cash (protected TFC) exists. Getting it wrong can reduce tax-free cash by a significant amount.

• Protected TFC does not require available LSA to be paid tax-free. Even if the LSA is fully used, protected TFC can still be taken without tax.

• LSA usage is assumed to be 25% of the amount crystallised, regardless of the actual tax-free cash paid.  

• Protected TFC is fully tested against the LSDBA, which acts as the true limiting factor. However, at £1,073,100, this allowance is unlikely to be hit for most clients.

• Crystallising pensions without protected TFC first can preserve LSA and allow protected amounts to be taken later, significantly increasing total PCLS.

• A lower remaining LSDBA is often not a material downside, as crystallised funds are not tested against it.

• With pensions increasingly relevant for IHT planning and age-75 considerations, maximising tax-free cash through correct sequencing is becoming more important than ever.
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Final thoughts

Although the introduction of the Lump Sum Allowance has simplified the headline rules, it has not removed the need for careful technical planning. And for clients with scheme-specific tax-free cash, the order in which pensions are crystallised can have a dramatic impact on outcomes.  

As pensions move further into the spotlight for retirement income and IHT, advisers who understand the interaction between the LSA, protected tax-free cash and LSDBA will be the ones adding real value.  

For more in-depth help with crystallisation strategy, reach out and speak to the team. We’re always available to help, and we love to chat!

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