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Tax-free cash and protection

Author Image The Technical Team
19 minutes read
Last updated on 6th Apr 2019

Overview

Tax-free cash (TFC) can be protected. The type of Lifetime Allowance protection held can also impact the calculation of the maximum TFC.

Key points

  • Lump sum rights (combining crystallised and uncrystallised) of over £375,000 on 5 April 2006 could be protected under either primary, enhanced or scheme specific protection.
  • For primary protection it is the monetary amount of tax-free cash rights at 5 April 2006 that is protected.
  • For enhanced protection the protected lump sum is quoted as a percentage, rather than a monetary value.
  • Primary and enhanced protection can also be held with no tax-free cash protection.
  • Scheme specific tax-free cash protection can apply for people who had tax-free cash rights at 5 April 2006 exceeding 25% of their fund on that date. 

When can TFC be more than 25%?

The standard rule is that maximum tax-free cash (TFC) is 25% of the pension value, subject to 25% of the member's available lifetime allowance (LTA). Tax-free cash can be protected though, and the type of LTA protection held can affect the calculation of TFC.

Bear in mind that specific scheme rules may restrict the amount of tax-free cash payable – regardless of whether protection is available or not.

Lump sum rights over £375,000 at A-day

Before covering protection of lump sum rights, it’s important to understand the valuation of lump sum rights at A-day.

When people notified HMRC of their intention to rely on primary or enhanced protection, it was also possible to protect lump sum rights that were more than £375,000 on 5 April 2006.

The value of lump sum rights on 5 April 2006 was the total of:

  • crystallised lump sum rights, plus
  • uncrystallised lump sum rights.

Basically, crystallised rights were the value of lump sum rights already taken, and uncrystallised were lump sum rights yet to be taken. Crystallised lump sum rights weren’t the actual amount of lump sums received, but one quarter of the value of the pension in payment.

Example

A gross annual pension of £50,000 has a crystallised value of (£50,000 x 25) £1.25 million.

One quarter of this is £312,500 and is the crystallised lump sum rights.

If there were benefits yet to be taken of £500,000 with lump sum rights of £200,000 the uncrystallised rights would be £200,000.

This would mean total A-day lump sum rights of £512,500.

The cash protected amount depended on the type of protection:

  • Primary: monetary amount i.e. £200,000 in the above example.
  • Enhanced: percentage of rights i.e. £200,000 / 500,000, 40% in the above example.

The amount of rights yet to be taken had to be within the old Inland Revenue permitted maximum lump sum.

It was also possible for lump sum rights of more than £375,000 to be protected without primary or enhanced protection where scheme specific protection applies.

Primary protection and tax-free cash exceeding £375,000

This applies where an individual applied for primary protection and protected their lump sum rights which exceeded £375,000 at A-day.

Paragraph 28 Schedule 36 Finance Act 2004

Where this applies it is the monetary amount of TFC rights at 5 April 2006 that are protected.

When an individual with primary and lump sum protection crystallises their benefits, the protected lump sum (i.e. the value on 5 April 2006) is increased in line with the increase in the standard lifetime allowance (SLA) to the date of crystallisation (underpinned lifetime allowance replaced SLA in April 2012 following reduction of the SLA – the underpinned lifetime allowance being the greater of the current standard lifetime allowance and £1.8m).

So from 6 April 2012, until such time as the standard lifetime allowance at the time the lump sum is taken is more than £1.8 million, the amount by which the pre-6 April 2006 lump sum rights are increased will always be 20% of their value on 5 April 2006.

Where rights were under £375,000 at 5 April 2006, standard tax-free cash rules apply (although £1.5m is used as the current standard lifetime allowance for the calculation (as detailed later)) – unless any scheme had scheme specific tax-free cash protection.

Interaction with lifetime allowance

One of the rules governing payment of tax-free cash is the individual must have some lifetime allowance available in order to receive TFC. So, at the benefit crystallisation event (BCE) date, the individual may take the current value of the protected lump sum, providing they have some personal lifetime allowance available.

Paragraph 1(1)(b) Schedule 29 Finance Act 2004

Example 

Alex had a personal lifetime allowance of £3 million (SLA of £1.5 million plus a factor of 1) and lump sum rights of £800,000.

In November 2016 she crystallised benefits to the value of £3 million plus a lump sum of £600,000. The underpinned lifetime allowance for 2016-17 is £1.8 million.

Alex's personal lifetime allowance = £3.6 million (£1.8 million plus factor of 1)

Maximum protected lump sum = £960,000 (£800,000 x 1.8 million/1.5 million)

As Alex has crystallised £3.6 million, she has used up her lifetime allowance. She could have taken the full lump sum and lower pension, scheme rules permitting.

If Alex then crystallised further benefits including another lump sum, she would be subject to a lifetime allowance charge. Although she didn’t use all of her protected lump sum, there’s no personal lifetime allowance left.

The TFC cash protected alongside primary protection is the maximum amount that can be paid from all schemes.

Example

TFC protected

£500,000 (increased to BCE date)

Scheme 1 – tax-free cash taken

£400,000

Scheme 2 – tax-free cash taken

£250,000 (being 25% of the members fund)

If the tax-free cash was taken in a previous tax year, the amount of cash taken is revalued by the change in the LTA from the year taken to the current BCE year (or £1.8m if higher) and subtracted from the revalued A-day value.

The maximum Scheme 2 should have paid was £100,000. The excess paid is an unauthorised lump sum payment, not a lifetime allowance excess lump sum, as the lifetime allowance has not been exceeded. If Scheme 2 paid the unauthorised payment as the member didn’t inform them of the full details, the scheme administrator is not liable for the scheme sanction charge. However, the member is still liable for the unauthorised payments charge.

Paragraph 30 Schedule 36 Finance Act 2004

Where the available lump sum is greater than the value of the scheme, it may be possible provided the additional conditions (listed later) are met to take all the benefits from a scheme as a standalone lump sum.

HMRC Pensions Tax Manual - PTM063110

Enhanced protection and tax-free cash exceeding £375,000

This applies where an individual applied for enhanced protection and protected their lump sum rights which exceeded £375,000 at A-day.

Lump sum protection is noted on the certificate as a percentage amount. The standard requirement that a TFC can only be paid when all or part of the member's lifetime allowance is available does not apply, as people with enhanced protection have unlimited lifetime allowance available.

Paragraphs 27 & 29 Schedule 36 Finance Act 2004
Article 18 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

If an individual’s lump sum rights at 5 April 2006 did not exceed 25% of their fund and did not exceed £375,000, then no lump sum protection applies – the standard lump sum rules apply (although £1.5m is used as the current standard lifetime allowance for the calculation (as detailed later)).

If enhanced protection is lost and the member has tax-free cash rights in excess of £375,000, and they are not relying on primary protection, their pre-A-day cash may still be protected within a scheme under scheme specific tax-free cash protection.

 Where an individual has protected their lump sum rights at 5 April 2006 and they have enhanced protection, the protected lump sum is held as a percentage rather than a value as for primary protection.

The value of the uncrystallised lump sum rights at 5 April 2006 is converted to a percentage by dividing it by the value of the uncrystallised pension rights at 5 April 2006 then multiplying by 100.

Example 

value of uncrystallised lump sum rights: £400,000 (called VULSR in the legislation)
value of uncrystallised pension rights: £2,000,000 (called VUR in the legislation)
400,000 ÷ 2,000,000 x 100 = 20%

The individual's TFC from each arrangement is then calculated by applying the above percentage to the value of the benefits actually coming into payment.

Example

value of benefits at BCE in Scheme 1 = £1,000,000
maximum TFC is 20% i.e. £ 200,000

Therefore, the individual cannot take 'the usual' 25% of the fund as TFC as the protected lump sum percentage takes precedent.

If an arrangement provides a lump sum that is less than the protected percentage, the balance CANNOT be paid by another arrangement.

Example

protected lump sum percentage 30%
scheme 1 pays PCLS of 25%

The remaining 5% cannot be 'transferred' or used by another arrangement - if it is not used, it is lost.

Tax-free cash for people with primary or enhanced protection and no tax-free cash protection

The Finance Act 2013 protects people who have primary or enhanced protection and no tax-free cash protection (PCLS entitlement of less than £375,000 at A-day). Assuming scheme specific PCLS does not apply, people in this situation will still retain the right to a PCLS of the lower of:

  • 25% of the value of the benefits, and
  • 25% of the standard LTA at the point of crystallisation. However, to ensure no disadvantage by the reduction in the LTA, which could result in benefits less than the entitlement at A-day, a lifetime allowance of £1.5 million is used rather than the standard LTA at the point of crystallisation.

If an individual with primary protection has had a BCE before 6 April 2014, and have another BCE after 5 April 2014, the earlier BCE will be revalued when working out availability of LTA as if the current standard lifetime allowance (CSLA) is £1.5 million. This means they won’t benefit when the LTA is reduced.

Where scheme specific protection exists it will work as per scheme specific tax-free cash below.

Scheme specific protection and tax-free cash

Who this applies to

This doesn’t apply to someone who has claimed primary or enhanced protection and has their pre-6 April 2006 tax-free cash protected as it exceeded £375,000. If the lump sum is protected through primary or enhanced protection, this takes precedence over scheme specific protection.

However, an individual with enhanced or primary protection can be eligible for scheme specific TFC protection, as their tax-free cash rights at 5 April 2006 didn’t exceed £375,000, but they did exceed 25%.

Unlike other forms of protection, there was no need to apply for scheme specific tax-free cash protection.

Schemes covered by this protection

The maximum TFC allowable after A-day is 25% of the fund. However, some occupational scheme members with pre-6 April 2006 rights had pre-A-day TFC rights greater than the 25% limit. Scheme specific TFC protection enabled the pre-A-day value to be protected.

See Paragraphs 31-34 Schedule 36 Finance Act 2004  

This TFC protection extends to:

  • occupational pension schemes
  • S32 (including ‘assigned to leaver’ policies)
  • old code schemes (schemes set up before 1970), and
  • statutory schemes (ie public sector schemes that are specifically set up and governed by legislation, e.g. civil service and local authority schemes). 

There is no similar TFC protection for retirement annuity contracts, (RACs) even though pre-A-day TFC entitlement could have been greater than 25% under the old 'three times residual annuity' basis. These contracts moved to a straight 25% calculation basis after 5 April 2006.

Tax-free cash can only be protected under schemes other than those outlined above if it exceeded £375,000 at A-day and is protected under primary or enhanced protection.

Paragraph 25(5)(a) Schedule 36Finance Act 2004

Criteria for scheme specific protection

For scheme specific protection to apply, three conditions must be met:

  1. the scheme paying the benefits must be the scheme in which the rights were held on 5 April 2006, or a scheme to which the benefits were transferred as part of a block transfer. Since 2006, (except for a short period of transitional flexibilities introduced in Finance Act 2014, which has now ended), where members had the right to a protected tax-free lump sum and / or a protected pension (from before 2006), these protections could continue in a new scheme only if transferred as part of a block transfer, also known then as a ”buddy transfer”. A block transfer, is where two or more members of a scheme have the value of their benefits transferred at the same time, in the same transaction, to another scheme. This is one of the few ways where protected lump sum / protected pension age could be retained on transfer.

    The Finance Act 2014 introduced a short period of transitional arrangements for those with a protected early pension age or a scheme specific protected tax-free cash amount. The transitional arrangements allowed transfer to another scheme, even where there was only one member transferring. This counted as a block transfer as far as retention of the protection was concerned. The transfer must have met the other block transfer rules, for example, it must have been for all of the benefits under the plan (i.e. no partial transfers). To benefit from these transitional arrangements, the transfer must have taken place on or after 19 March 2014 and before 6 April 2015. The member must have then become entitled to all benefits before 6 October 2015.

    Since 6 April 2015 single member transfers have been retained for protected retirement ages in respect of pensions in payment, but other than cases transferred under the transitional arrangements, the original block transfer rules have been reapplied in respect of protected lump sum payments and protected retirement age.
  2. the uncrystallised lump sum rights at 5 April 2006 must have been more than 25% of the uncrystallised pension rights in that scheme on that day, and
  3. entitlement to benefits must arise under all arrangements under the scheme at the same time.

Uncrystallised pension rights and lump sum rights

The value of an individual's uncrystallised pension rights and lump sum rights in the scheme on 5 April 2006 are known as VUR and VULSR respectively.

Where VULSR ÷ VUR x 100 is more than 25%, the legislation allows for TFC greater than 25% to be paid to the person.

There was no need to register this form of lump sum protection with HMRC, – it’s provided automatically by the legislation. A scheme is not compelled by legislation to provide the maximum lump sum.

Calculation of tax-free cash lump sum where a member has scheme specific protection

The formula to calculate the TFC is different depending when the lump sum was taken. If this was before April 2011 or between April 2011 and 2012, then the formula is slightly different.

Finance Act 2004: Sch 36, Para 34

Formula from 6 April 2012

The amount of TFC is found by using this formula:

(VULSR x ULA / FSLA) + ALSA

VULSR is the value of the individual's uncrystallised lump sum rights under the scheme on 5 April 2006.

ULA is the greater of £1.8 million and the standard lifetime allowance when benefit entitlement arises.

FSLA = £1.5 million.

ALSA is the amount found by the formula:

[LS + {AC - (VUR X CSLA / FSLA)}] / 4

CSLA is the current standard lifetime allowance, or £1.8 million where this is greater, and the individual has fixed protection 2012, this is £1.5 million for fixed protection 2014 and £1.25m for fixed protection 2016. For those with Individual Protection 2014/16, the figure to use for CSLA is the member’s own protected lifetime allowance.

LS is the amount of pension commencement lump sum actually paid.

AC is the amount actually crystallised by becoming entitled to a pension in connection with which the pension commencement lump sum is paid, or the amount of the trivial lump sum paid (more information on trivial lump sums and protection can be found here). Where a scheme pension is paid from a money purchase arrangement, AC will be the scheme pension purchase price, i.e. the value of the sums and assets made available to provide the scheme pension. Where the member becomes entitled to the connected pension after reaching 75, even though there is no actual benefit crystallisation event, AC is the amount that would have crystallised had there been such an event.

VUR is the value of the individual's uncrystallised rights under the scheme on 5 April 2006.

If the formula gives a negative result, ALSA will be nil and no further additional lump sum can be paid.

The difference in CSLA depending on the existence or not of fixed protection means there’s a difference in amounts of TFC payable.

Example 

For a case where the member doesn’t have fixed protection

A-Day fund £100,000
Protected TFC £60,000
Current fund £200,000

[£60,000 x (£1.8m/£1.5m)] + {[£200,000 - (£100,000 x £1.055 / £1.5)] / 4}

= £104,417

For a case where the member has fixed protection 12

[£60,000 x (£1.8m/£1.5m)] + {[£200,000 - (£100,000 x £1.8 / £1.5)] / 4}

= £92,000

For a case where the member has fixed protection 14

[£60,000 x (£1.8m / £1.5m)] + {[£200,000 – (£100,000 x £1.5 / £1.5)] / 4}

£97,000

For a case where the member has fixed protection 16

[£60,000 x (£1.8m / £1.5m)] + {[£200,000 - (£100,000 x £1.25 / £1.5)] / 4}

£101,167

For a case where the member has individual protection 16 of say £1.2m

[£60,000 x (£1.8m / £1.5m)] + {[£200,000 - (£100,000 x £1.2 / £1.5)] / 4}

£102,000

This is a key difference after April 2012. The formula in the legislation means that if a member has fixed protection and scheme specific protection, they’ll be entitled to a lower amount than if fixed protection wasn’t held.

Loss of scheme specific tax-free cash protection

When benefits under a scheme with lump sum protection are transferred to another scheme, the lump sum protection is lost unless the transfer is a block transfer.

There were transitional arrangements for transfers between 19 March 2014 and 5 April 2015, but since 6 April 2015 the original block transfer rules have been reapplied for scheme specific TFC protection.

Since 6 April 2015, a block transfer for scheme specific TFC protection is where two or more members of a scheme transfer all the sums and assets of the one scheme to another. They must both transfer to the same destination scheme.

It must be done in a single transaction and there can’t have been previous membership in the receiving scheme for more than 12 months.

A single transaction isn’t defined, but in principle all the transfers have to happen as part of one agreement. Practicalities may dictate that transfers take place at different times, but as long as all transfers from the agreement proceed within a reasonable timeframe, a block transfer should have been made.

The scheme receiving the transfer can be any type, and so can be a personal pension, providing the other conditions relating to the block transfer are met.

A number of sequential block transfers can be made without affecting the lump sum protection, providing they each meet the block transfer requirements.

A partial transfer can’t be a block transfer. If a partial transfer takes place, the protected lump sum in the transferring scheme is reduced by 25% of the transfer value. Please note that this reduction does not apply to pension debits from a pension sharing order. 

There are certain scenarios where a transfer can be treated as a block transfer, even when it isn't (and might involve one-member schemes such as section 32s or occupational schemes with one member). For this to happen, the winding-up scheme condition and the annuity condition must be met, as described at PTM063150.

It isn’t possible for a member to have two protected tax-free cash amounts in one scheme. 

Finance Act 2004: Schedule 36, Paragraph 31(7 - 9)
HMRC Pensions Tax Manual PTM63130, PTM063140, PTM063150

The Pension Schemes (Block Transfers) (Permitted Membership Period) Regulations 2006 - SI 2006/498

Articles 13-16 The Pension Schemes (Transfers, Reorganisations and Winding Up)
(Transitional Provisions) Order 2006 - SI 2006/57

Transitional flexibility - block transfer amendments

As part of the transitional flexibilities introduced in Finance Act 2014, the requirement for a block transfer to have at least two members was temporarily relaxed. This meant people in single member schemes, who were previously unable to transact a buddy transfer, were able to transfer and maintain their protection.

The transfer must have met the other block transfer rules, for example it must be for all of the benefits under the plan (ie no partial transfers). The existing quirk preventing a single scheme from having two different protected tax-free cash amounts continues.

The transfer must have taken place on or after 19 March 2014 and before 6 April 2015, so the opportunity to access the transitional flexibility has passed. The member must then have become entitled to all benefits before 6 October 2015. If entitlement hadn’t arisen by this date, any protection was lost and any payments made became unauthorised.

This amendment to the block transfer rules also applied to those with entitlement to a protected early retirement age. Post April 2015, the entitlement to affect a single transfer and retain protected retirement age has been retained for pensions in payment. However, the rules have reverted to the original block transfer rules in respect of Protected Lump Sum entitlement and Protected Retirement Age for uncrystallised funds.

Stand-alone lump sum

A standalone lump sum is similar to scheme specific protection, except the whole fund was available as TFC at 5 April 2006.

If the total lump sum rights at 5 April 2006 are equal to the total pension rights, the protected percentage is 100%. This is still treated as a TFC lump sum and triggers a BCE6 test, but is called a stand-alone lump sum. There’s no requirement for a stand-alone lump sum to be linked to an arising entitlement to pension.

From 6 April 2011 they can be paid to those over 75 as well as those under 75. However, if payment occurs after the age of 75 this is not a BCE.

Like all lump sums, the member must have personal lifetime allowance available for the payment to be made.

The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572, articles 25-25D

To pay a stand-alone lump sum:

  • the member must have reached the normal minimum pension age (or any earlier protected pension age or satisfy the conditions for an ill-health pension)
  • all the benefits under the pension scheme must be paid out at the same time as a single BCE
  • the lump sum is 100% in all the member's arrangements under the scheme (it can’t apply to just one).

A stand-alone lump sum can also be paid where a member has Primary Protection with protected lump sum rights as explained above. NB this payment would trigger the Money Purchase Annual Allowance.

Fixed protection and tax-free cash

TFC isn’t specifically protected by fixed protection as it is for primary or enhanced protection.

TFC calculations are calculated in a similar way to someone with no protection, except those with fixed protection have a LTA relevant to the type of fixed protection they hold (FP12 -£1.8 million for all purposes, FP14 -£1.5 million for all purposes and FP16- £1.25 million for all purposes). This causes two differences from the 'norm':

Standard TFC

Under Fixed Protection 2012, the member is allowed up to 25% of £1.8 million (£450,000) rather than 25% of the LTA at that point in time. Under Fixed Protection 2014, the member is allowed up to 25% of £1.5 million (£375,000)and under Fixed Protection 2016 the member is allowed up to 25% of £1.25 million (£312,500). At the time of writing, the LTA is £1.055 million (TFC of £263,750). If the standard LTA rises to more than the protected LTA, the member with fixed protection will be entitled to 25% of the higher figure.

Scheme specific TFC

Due to the formula for calculating scheme specific TFC amounts, the fixed LTA of £1.8 million means those with scheme specific protection for TFC along with their fixed protection get lower TFC than those without fixed protection.

Overview of all protections

Tax-free cash protection

Calculation

Maximum

Primary with tax-free cash protection

amount on certificate increased by (underpinned LTA / LTA at A-day).

Available personal LTA based on underpinned LTA.

Primary with no tax-free cash protection

up to 25% of available CSLA but the CSLA is read as being £1,500,000

£375,000

Enhanced with enhanced tax-free cash protection

% of fund value using percentage stated on protection certificate.

 N/A

Enhanced with no tax-free cash protection

up to 25% of available CSLA but the CSLA is read as being £1,500,000

£375,000

Scheme specific

value at A-day increased by (CSLA* or ULA) plus 25% of post A-Day fund.

Available LTA, either: personal, enhanced, fixed or standard.

Fixed Protection 2012

up to 25% of available fixed LTA of £1.8m

£450,000

Fixed Protection 2014

up to 25% of available fixed LTA of £1.5m

£375,000

Individual Protection 2014

up to 25% of the available personal LTA

£375,000

Fixed Protection 2016

up to 25% of available fixed LTA of £1.25m

£312,500

Individual Protection 2016

up to 25% of the available personal LTA

£312,500

No Protection

up to 25% of available standard LTA of £1.055m

£263,750

* The additional lump sum part of the calculation uses CSLA. For those with Fixed Protection 2012 it’s £1.8million, £1.5million for those with Fixed Protection 2014, £1.25million for those with Fixed Protection 2016 and the relevant amount, which is £1.25--£1.5million for those with individual protection 2014 and £1-£1.25million for those with individual protection 2016

 

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