Pension Tax Allowances and Defined Benefit Transfers: What You Need to Know

The lifetime allowance (LTA) used to be out of reach for most but is now being factored in more and more with those looking to transfer out of a defined benefit scheme.

Before April 2024, the Lifetime Allowance was the maximum allowable to be saved into a pension without paying an additional tax charge. The allowance was £1,073,100 and had been as high as £1.8m in previous years. Since its abolition, the key limits to be aware of are the Lump Sum Allowance (£268,275) which caps the tax-free cash you can take, and the Lump Sum and Death Benefit Allowance (£1,073,100).

The penalty for breaching the LTA is a 55% tax levy on funds above the allowance if taken as a lump sum or 25% if taken as an income (you will pay income tax on withdrawal also, roughly equalising the tax paid as if taken as a lump sum). 

The limit applies to the total value of all your pensions including Final Salary (Defined Benefit, DB) and Personal/Group personal pensions (Defined Contribution, DC) schemes.

The major difference between DB and DC schemes when it to the old LTA rules was the way they are calculated for LTA purposes. With DC schemes it’s simply the fund value against the LTA limit whereas with DB schemes it’s the value of the annual income x 20, plus any tax-free cash.

The way that DB schemes are calculated most often means it uses substantially less of your LTA allowance than the equivalent value of the offered transfer amount.

For example.

A DB offers an income of £20,000 with a lump sum of £100,000 or a cash equivalent transfer value of £600,000.

Using the DB LTA calculation method – 20 x £20,000 = £400,000 plus the £100,000 tax-free cash is £500,000.

Taking the Cash Equivalent Transfer Value is £600,000.

You are therefore using £100,000 more of your allowance by transferring the DB into a DC scheme, than taking the benefits directly from the DB scheme.

You should therefore consider carefully the advantages of transferring a DB scheme, particularly in light of the new pension tax allowances.

Another factor to consider is the potential growth of the transferred scheme. If the resulting transfer takes you close to the limits, for example £900,000, any potential future years growth could trigger the tax charge. A way to avoid this could be to crystallise the funds before they reach the limit. This effectively prevents any future growth triggering the charge, Previously there was a second LTA test at age 75, though this no longer applies following the April 2024 changes.

Learn about What affects Defined Benefit transfer Values?

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