The lifetime allowance and fiscal drag

4 minute read

The abolition of the Lifetime Allowance (LTA) in April 2024 was positioned as a bold move to simplify pension taxation and encourage older workers to remain in or return to the workforce (many of whom we value in our public services). For many, it signalled the end of punitive tax charges on pension savings above a certain threshold - previously capped at £1,073,100. However, while the LTA is no longer part of the pension landscape, its spirit lives on through a new regime of fixed allowances that will almost certainly quietly erode pension value over time.

The new landscape: Lump sum limits replace the LTA

In place of the LTA, the government introduced two key allowances:

Lump Sum Allowance (LSA): Capped at £268,275, this is the maximum amount an individual can take as tax-free lump sums from their pensions during their lifetime.

Lump Sum and Death Benefit Allowance (LSDBA): Set at £1,073,100, this limits the total tax-free lump sums payable on death or in cases of serious ill-health.

Any lump sums taken above these limits are taxed at the individual's or beneficiary’s marginal income tax rate. While these allowances may appear generous, they are fixed with no provision for indexation or inflationary adjustment.

The problem with fixed allowances

Unlike the LTA, which was periodically reviewed and adjusted, the new lump sum allowances are static. This shifts the subtle but significant issue of fiscal drag.

As pension pots grow and inflation pushes up the cost of living, the real value of the tax-free lump sum allowance diminishes. What feels like a substantial benefit today may be far less impactful in 5, 10 or 20 years. Without inflation-linked increases, more retirees will find themselves breaching these thresholds - not because they are excessively wealthy, but because the allowances have failed to keep pace with economic reality.

Consider these inflation-adjusted values of the LSA and LSDBA over time, assuming a consistent 2% annual inflation rate:

Years ahead	Adjusted LSA (£268,275)	Adjusted LSDBA (£1,073,100)
5 years	£296,197.28	£1,184,789.11
10 years	£327,025.73	£1,308,102.91
20 years	£398,642.54	£1,594,570.15

This clearly shows how the real value of the fixed allowances erodes over time if they are not indexed to inflation. In 20 years, the original LSA would need to be nearly £130,000 higher just to maintain its current purchasing power. If we use an inflation rate of 3% this figure balloons to over £216,000 in 20 years.

Impact on Retirement Planning

This shift has several implications:

Reduced flexibility: The fixed LSA may limit retirees' ability to take larger tax-free lump sums when needed - such as for home improvements, debt repayment, or healthcare costs.

Increased tax exposure: As more individuals exceed the LSA or LSDBA over time, a greater portion of their pension withdrawals will be taxed, reducing net retirement income.

Complexity in legacy planning: The LSDBA introduces new considerations for estate planning, especially for those with larger pension pots or multiple beneficiaries.

Protection still matters

Individuals with existing LTA protections - such as Enhanced or Primary Protection - may retain higher tax-free lump sum entitlements. However, these protections are complex and require careful management. For example, Enhanced Protection may allow for tax-free cash above £375,000, but only if specific conditions are met.

Looking Ahead

While the removal of the LTA was intended to simplify pensions and incentivise work, the introduction of fixed lump sum allowances may have the opposite effect over time. The lack of indexation means that what is tax-free today may become taxable tomorrow—not due to policy changes, but due to economic drift.

For advisers and clients alike, this underscores the importance of ongoing review and strategic planning. Understanding how these new allowances interact with existing benefits, protection schemes, and retirement goals is essential to avoid unexpected tax liabilities and to preserve the value of pension savings.

Approver: Quilter Cheviot Limited, 13 October 2025

The value of pensions and investments and the income they produce can fall as well as rise. You may get back less than you invested.

Tax treatment varies according to individual circumstances and is subject to change.

David Denton (FPFS TEP)

Head of Technical

David is a Trust and Estates Practitioner. His primary role is to simplify, update and share technical knowledge, within the Quilter group, and the legal and accounting firms we and our clients work with.

This is to ensure that post-tax investment returns are maximised, despite complex and fast changing legislation impacting wealth management.