Transitional tax-free amount certificate: How it works

The previous Labour government introduced ‘pension simplification’ in 2006, with the aim to get rid of unnecessary complexity from the pension landscape and remove barriers to retirement planning.

Central to Labour’s changes were the introduction of annual and lifetime allowances, and a single tax regime for all pensions. This included tax relief on contributions and the ability to withdraw a tax-free lump sum of up to 25% at a specific age.

While this may have largely made pensions less complicated at the time, the reality for most people is that pensions have never been simple. So many factors, such as the type of pension, your earnings and your age, all play a part in both the contributions you can make and when and how you can make withdrawals. And it’s a picture that keeps evolving.

UK pensions changes explained

There’s no longer an upper limit to the amount of pension funds or benefits that can be accrued without tax charges. Instead, there are two new allowances – the lump sum allowance (LSA) and the lump sum and death benefit allowance (LSDBA). These will limit the amount of lump sums that can be paid tax-free during an individual’s lifetime and on their death.

The lump sum allowance

The LSA is the amount of tax-free cash you can take from your pension. It’s capped at £268,275 (25% of the former £1,073,100 lifetime allowance [LTA]).

The lump sum and death benefit allowance

The LSDBA is set at £1,073,100 and is the cumulative total amount that can be paid out as tax-free lump sums during your lifetime and on your death.

The figures above are the default amounts for the LSA and the LSDBA. However, if you have any fixed or individual protections in place, your LSDBA will be set to the level of your protected lifetime allowance while your LSA will be set to 25% of this amount.

Pension commencement lump sums (PCLS) and the tax-free amount of uncrystallised funds pension lump sums (UFPLS) will be tested against and use up both LSA and LSDBA. Serious ill-health lump sum death benefits will also use up the LSDBA.

It’s also possible, however, to potentially take out more tax-free money than the limits specified in the LSA or LSDBA through a transitional tax-free amount certificate (TTFAC).

“The certificate could make a real difference to the tax-free amount you can claim,” explains Shazna Bishop, Financial Planner and Divisional Director with RBC Brewin Dolphin. “But this is a really complicated part of pension planning and financial advice should absolutely be taken because you could actually come off worse instead of better.”

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Is the transitional tax-free amount certificate right for you?

If you have used up some (or all) of your LTA prior to 6 April 2024, the new LSA and LSDBA allowances will be adjusted to reflect that. Essentially, there’s a default calculation that looks at the amount of the LTA you have used, and 25% of that will be deducted from the new allowances.

“The main problem with the default calculation is that it assumes you’ve taken 25% as a tax-free lump sum every time benefits were crystallised prior to 6 April 2024,” says Bishop. “But this might not actually have been the case.”

Whether you were in a Defined Contribution or a Defined Benefit scheme, it’s important to check if you’ve taken any tax-free sums from your pot, and if so, how much. You can find this out by writing to your pension scheme. Once you have this to hand, a financial adviser can calculate how much tax-free money you’ve taken and whether you’d benefit from applying for the TTFAC. 

Obtaining a TTFAC ensures that the actual amount of tax-free lump sums taken before 6 April 2024 is accounted for, rather than an assumed amount. This potentially means you could take up to 25% tax-free cash from future withdrawals (rather than a figure based on the assumed calculation). Also, the TTFAC could increase the LSBDA, which could be important if a death benefit is expected to be paid.

It’s possible that you could benefit from a TTFAC if any of the following apply:

• You’ve taken no tax-free cash (or less than 25%) when you accessed your pension – by taking an annuity or through a Defined Benefit Scheme, for example
• You’ve not crystallised any benefits from your pension since 6 April 2024 (if you have, you won’t be able to apply for the TTFAC)
• You moved an element of your UK pension to an overseas scheme (QROPS)
• You’re over 75 and had standard LTA checks when you reached that age
• You took a pension benefit during the four tax years (2016/17 to 2019/20) when the LTA was lower than £1,073,100
• You’ve taken a serious illness pension lump sum in the past
• You’ve received part of someone else’s pension through a pension sharing order.

Even if one of the above applies, your overall tax-free cash position needs to be compared to the standard calculation. If you have multiple pensions, for example, you might have taken less than 25% tax-free cash from one but also taken 25% from another when the LTA was much higher. As a result, the standard calculation might put you in a better position.

Make sure to do the calculations

“It’s really important that these calculations are done before you apply for a TTFAC,” says Bishop. “You need to gather all the evidence of the lump sums you’ve taken, along with how much of your LTA you have used. Your financial adviser can do this with your permission, but you have to make the application to the pension scheme yourself.”

If your calculations show that the tax-free lump sums you’ve taken prior to 6 April 2024 are less than 25% of the LTA used, you can present the evidence to your pension scheme and ask them for a TTFAC. This certified figure will then be deducted from your LSA and LSBDA.

Critically, once the TTFAC is issued, it can’t be revoked, even if the certified amount is less that the standard calculation. So, it’s vital to double check all calculations before applying.

“It’s also important to know that if you’re applying for the certificate, you need to do so before your pension crystallises. Once you take a tax-free lump sum from your pension, the standard calculation will apply,” says Bishop. “So, if you’re planning on taking pension benefits, you must make sure the TTFAC is in place before you do this.

The importance of reviewing your pensions

Carrying out the calculations and deciding whether to apply for a TTFAC really does demonstrate the need to not only have a view across all your pension schemes, if you have more than one, but also to know what’s happening ‘under the bonnet’ of each pension.

The role of pensions in broader retirement and estate planning has also arguably never been more important – not least because the government announced future changes to pension rules, which will see pensions become liable to inheritance tax (IHT) from 6 April 2027.

“Quite often, the pension pot is the last pot someone would touch in retirement,” says Bishop. “But if the new rules around IHT come into force, you may decide that it’s best to crystallise a pension in some way. It’s here that checking your TTFAC calculation could be really important. And financial advice will go a long way to helping you make the right decision.”

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The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should always check the tax implications with an accountant or tax specialist. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

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