Potential tax trap
in new tax-free pension lump sum allowance regime

Our viewpoint

Members can apply for “transitional protection” from the new tax-free pension lump sum allowance regime coming into force on 6 April 2024 but they might end up worse off - administrators, trustees and employers therefore need to be really careful in member communications.

Each time the pensions tax regime changes HMRC has to work hard to put in place transitional protections to help ensure that individuals who have built up existing benefits under the old regime are not unfairly penalised by the switch to the new regime.

When it came to reductions in the Lifetime Allowance, a series of protections were made available, such as Fixed Protection and Individual Protection. Individuals had a window in which to apply but they could be safe in the knowledge that they could be no worse off as a result of obtaining the protection.

The new tax-free lump sum allowance regime coming into force on 6 April 2024 is different. There is a transitional protection mechanism (the “transitional lump sum certificate”) and it will be advantageous for a few (but probably very few) people to apply. However, the way it is structured means obtaining the certificate could be detrimental for many others if they are up against the new tax-free lump sum allowances. And, once a certificate is obtained, it cannot be surrendered.

This means that individuals need to be careful and not to apply for the transitional certificate unless they are confident it will be to their benefit. 

A further complication for individuals is that they can only apply for a transitional certificate before their first tax-free lump sum payment in the new regime. So, individuals will need to think through whether the new tax-free lump sum allowances might affect them and the consequences of applying for the certificate on their pension arrangements as a whole before taking any benefits under the new regime – otherwise it might be too late.

This all means that administrators, trustees and employers need to be really careful in member communications. The ability to obtain the transitional certificate needs to be communicated in a balanced way with appropriate warnings – no one wants to face a claim that their communications or processes led to an individual increasing their tax bill.

If you would like to talk through how this option can be communicated to your members, do let us know.

My blog, dated 28 February 2024, contains a wider checklist regarding the new pensions tax regime.