Some individuals who are members of occupational pension schemes or section 32 policies are afforded a degree of protection, known as scheme specific tax-free cash protection. This article explains how this protection works.
Who calculates the A-Day tax-free cash rights?
The Scheme will calculate the value of an individual’s lump sum rights at 5 April 2006. However, it is the responsibility of the scheme trustees to sign this calculation off as being correct.
How does the protection work?
The protection is specific to a particular scheme. The cash value of an individual’s tax free lump sum rights will be protected automatically where it exceeds 25% of the value of the members pension rights under the scheme on 5 April 2006.
When the member subsequently decides to take their pension benefits the amount of protected tax-free cash that can be payable will be recalculated at that point. There are two elements to this calculation:
- Revalue the A-Day protected cash value by 20%, and
- Add an additional lump sum amount equivalent to 25% of the difference between the current value of the pension rights and the value of the A-Day pension rights. As from April 2014 the standard lifetime allowance reduced to £1.25 million, which is below the original A Day lifetime allowance figure, there is now an additional element to the calculation that needs to be done to revalue the available tax free cash sums from the post A Day pension accrual. The additional lump sum calculation now =; current value of uncrystallised pension funds - (A Day value of uncrystallised pension funds x (current LTA/£1.5 million)) x 0.25. In this circumstance the current LTA will be £1.25 million.
For example, on 5 April 2006 Terry’s total pension rights under an executive pension scheme amounted to £200,000. From this he could take £80,000 as a tax-free lump sum. As this exceeded 25% of the value of the fund Terry qualified for scheme specific tax-free cash protection. By 20 June 2013 Terry’s pension rights had increased to £300,000, at which point he decided to take benefits. Terry’s maximum tax-free cash lump sum is:
- The £80,000 A-Day tax-free cash increased by 20% = £96,000, plus
- 25% of the difference between the current value of the pension rights and the value of the A-Day pension rights after revaluation, so; £300,000 - (200,000 x (£1.25million/£1.5million)) x 0.25 = £33,333
Total = £129,333
Please note – for individuals who rely on Fixed Protection the A-day fund value will be uplifted assuming an underpinned lifetime allowance of £1.8 million. This means that they will have a lower additional lump sum amount than those without Fixed Protection. Using the same example above but for an individual with Fixed Protection we get the following:
- The £80,000 A-Day tax-free cash increased by the increase in the Lifetime Allowance (assuming LTA of £1.8 million) = £96,000, plus
- 25% of any increase in the value of his pension scheme since 6 April 2006 above the increase in the Lifetime Allowance (assuming underpinned LTA £1.8million) [£300,000 – (£200,000 x £1.8m/£1.5m)]/4 = = £15,000
Total = £111,000
Partial Transfers – What happens to the protected tax-free cash if part of the member's pension rights are transferred out?
Where an individual makes a partial transfer out of a protected scheme the amount of the protected tax-free cash that can paid is reduced. The reduction is equal to ¼ of the transfer value.
For example, on 5 April 2006 Jon’s total pension rights under a section 32 policy amounted to £275,000. From this he could take £100,000 as a tax-free lump sum. As this exceeded 25% of the value of the fund Jon qualified for scheme specific tax-free cash protection.
In 2010 Jon transferred £50,000 out of the section 32 to another pension arrangement.
By 20 August 2014 Jon’s pension rights had increased to £310,000, at which point he decided to take benefits. Jon’s maximum tax-free cash lump sum is:
- The £100,000 A-Day tax-free cash increased by 20% = £120,000, plus
- 25% of the difference between the current value of the pension rights and the value of the A-Day pension rights increased by the increase in the Lifetime Allowance over the period [£310,000 – (£200,000 x £1.25m/£1.5m)]/4 = £35,833 Minus ¼ of £50,000 = £12,500.
Total = £143,333 (£120,000 + £35,833 - £12,500)
What affect does a pension debit have?
Where a member's rights are reduced due to the transfer out of a pension debit the individual’s protected tax-free cash remains unchanged.
Are there any conditions to be met on taking benefits?
Yes. The individual must take all the pension and lump sum rights under the scheme on the same day. This means it is not possible to take the protected tax-free cash in phases.
What happens to the protected tax-free cash if a full transfer is made between pension schemes?
It is possible to retain entitlement to the protected tax-free cash under the new scheme but only if the transfer was conducted as a ‘block transfer’. See our ‘block transfer’ article for further information.
The information required to calculate the 5 April 2006 protected tax-free cash amount may, for some individuals, be as simple as providing remuneration details for the employment period concerned. However, some may also have to provide the A-Day values of other accumulated pension rights. For clients who are members of multiple schemes for the same employment, the situation is further complicated by the need to apportion the individual’s tax-free cash between the schemes. This usually involves Schemes sharing information to agree the apportionment split, which can take time.
As time passes, access to the relevant information may become difficult to obtain. It is therefore important to ascertain an individual’s lump sum rights even where retirement may be some years hence. Old Mutual Wealth has been active in this process since A-Day, and for members of our occupational schemes a maximum benefit A-Day questionnaire is available to help obtain the information required to complete lump sum calculations.