How to Maximise The Highest 25% Tax-free Lump Sum

Jun 4, 2024 | Advice, Ben Eccles, Tax

How to Maximise The Highest 25% Tax-free Lump Sum

Jun 4, 2024 | Advice, Ben Eccles, Tax

To take more tax-free lump sum from a UK pension by having fixed protection in place, you need to understand the intricacies of pension protection schemes and how they interact with the tax-free lump sum rules. Here’s a step-by-step guide:

1. Understand Fixed Protection

Without any fixed protection the maximum tax-free lump sum you can take is GBP 268,275. However, this tax-free lump sum could be bigger with the right planning.

Fixed Protection is a scheme HM Revenue & Customs (HMRC) introduced to protect individuals with larger pension pots from the reduction in the Lifetime Allowance (LTA). The different versions of Fixed Protection include:

Fixed Protection 2012: Set the LTA at £1.8 million.
Fixed Protection 2014: Set the LTA at £1.5 million.
Fixed Protection 2016: Set the LTA at £1.25 million.

2. Eligibility for Fixed Protection

To be eligible for Fixed Protection, you must meet the following criteria:

You should have applied before the relevant deadlines (the 2012 and 2014 deadlines have passed, but Fixed Protection 2016 can still be applied for).
You must not have any contributions paid to your pension scheme after 5 April 2016.
No new pension arrangements can be started, and no benefit accrual is allowed.

3. Tax-Free Lump Sum

Under current UK pension rules, you can usually take up to 25% of your pension pot as a tax-free lump sum. The amount of tax-free lump sum you can take is capped at 25% of the standard LTA or your protected LTA, whichever is higher.

4. Using Fixed Protection to Increase Tax-Free Lump Sum

If you have Fixed Protection, your protected LTA can be higher than the standard LTA. For example, with Fixed Protection 2016, your LTA is protected at £1.25 million instead of the reduced standard LTA (which has been lower in recent years).

Calculate Tax-Free Lump Sum with Fixed Protection 2016: If you have Fixed Protection 2016, your LTA is £1.25 million. Therefore, the maximum tax-free lump sum you can take is 25% of £1.25 million, which equals £312,500.

5. Application and Maintenance

Applying for Fixed Protection: You need to have applied for Fixed Protection 2016 online through the HMRC website.
Maintaining Fixed Protection: Ensure no further contributions are made to your pension pot, no new arrangements are started, and no benefit accrual occurs after the protection date.

6. Steps to Take the Lump Sum

Check Your Pension Value: Ensure you know the total value of your pension pot.
Calculate the Lump Sum: Determine 25% of your protected LTA.
Consult with Pension Provider: Inform your pension provider of your intention to take a tax-free lump sum.
Verify Compliance with Fixed Protection: Ensure all actions comply with the conditions of Fixed Protection to avoid losing it.

7. Professional Advice

Given the complexity and potential for significant tax implications, it’s advisable to:

Consult a Financial Advisor: Speak with a pension specialist or financial advisor to ensure you’re making the most of your fixed protection.
Stay Informed: Keep up-to-date with any changes in pension laws and protections that might affect your situation.

By carefully managing your pension under the rules of Fixed Protection, you can maximize the tax-free lump sum available to you, thereby enhancing your retirement planning.

Written by: Ben Eccles – Independent Financial Adviser

This communication is for informational purposes only based on our understanding of current legislation and practices which are subject to change and are not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.