A Section 32 policy is bought from an insurance company using funds from a registered pension scheme.
Section 32 policies can be used if an occupational scheme is about to wind up, and / or a member has left employment and wishes to transfer to a deferred annuity contract.
Pensions tax rules are broadly the same for Section 32 policies and personal pensions. But Section 32 policies are one-member schemes, with potential restrictions.
Tax-free cash is similar to any other registered pension, although your client may be entitled to a larger lump sum under their previous scheme rules at 5 April 2006.
Section 32 providers must guarantee to pay any guaranteed minimum pension (GMP), as a result of contracting-out under the previous scheme, at age 60 for females/65 for males, and must make up any shortfall to provide the GMP.
If your client’s scheme rules don’t offer flexibility, they may be able to transfer to a scheme that does. However, this could affect protected early retirement age and tax-free cash, along with any GMP.
What is a Section 32 or buyout policy?
A Section 32 or buyout policy (aka a deferred annuity plan) accepts the transfer of funds from an occupational pension scheme.
Pension Section 32 is a policy or contract bought from an insurance company using funds from a registered pension scheme. The policy provides for an annuity at some point in the future – a deferred annuity contract.
It’s called a Section 32 policy as this was the section in the Finance Act 1981 that referred to deferred annuity contracts. It can also be referred to as a 'buyout' policy, as the member's benefits rights have been 'bought out' of the registered pension scheme. The benefits can be secured by one or more policies or from one or more insurance companies.
Before A-Day, Section 32 policies were governed by section 591(g) of Income and Corporation Taxes Act 1988. Now they’re classified as registered pension schemes within the terms of Chapter 2 of Part 4 of Finance Act 2004
When would a Section 32 policy be used?
Section 32 policies could be used if:
the occupational scheme is about to wind up and / or
the member has left the employment of the employer running the occupational scheme and they wish to transfer to a deferred annuity contract rather than another employer's scheme, personal pension, or stakeholder pension.
What’s the difference between a Section 32 policy and a personal pension?
A Section 32 policy cannot receive any further contributions or separate transfer value payments once it is set up.
Since A-Day, they’re both treated the same way for pensions tax purposes. However before A-Day, the main differences were that a Section 32 policy:
was governed by occupational rules and limits on the benefits that could be taken, and
accepted guaranteed minimum pensions (GMP) derived from the ‘contracting out’ of salary related pension schemes from the state earnings-related pension / State Second Pension schemes
While the rules are generally the same for both after A-Day, the differing pre A-Day structure means Section 32s are one-member schemes. So they’re likely to have protected tax-free cash and possibly restrictions within the policy terms. The need to provide for a GMP at age 60/65 can restrict the ability to take benefits or transfer before that age, if the fund can’t secure the required level of GMP.
Block transfers and Section 32s
A block transfer allows a member to transfer to a new scheme (subject to criteria) while keeping any entitlement to protected tax-free cash or a protected early retirement age.
To qualify as a block transfer before Finance Act 2014 required more than one member to transfer from the same existing scheme (scheme A) to the same new scheme (scheme B) in a single transaction, commonly called a buddy transfer. This requirement was temporarily relaxed as part of the Freedom and Choice Transitional Flexibility, meaning a single member could block transfer to a new scheme and retain their entitlement(s).
The transfer must have taken place between 19 March 2014 and 6 April 2015, and entitlement must have arisen prior to 6 October 2015 (by entering drawdown, for instance).
When this temporary relaxation of the block transfer rules passed we reverted back to the original rules. So if a protected retirement age or protected tax-free cash entitlement is to be retained on transfer, more than one member must transfer in a single transaction. Because a S32 is a single member arrangement, then this type of scheme cannot facilitate a block transfer except to another S32 contract, covered later.
An individual Section 32 policy is a single member scheme, meaning it couldn’t previously have made a block transfer. A Section 32 contract from which the whole of a member's rights are transferred (on or after 6 April 2006) can be treated as though the scheme is winding up. So protected lump sum rights and / or a protected pension age can be retained following transfer of the whole of a member's rights under an S32 contract to a new S32 contract. The same is true in the case of a subsequent transfer to S32. (N.B. a transfer to any other type of contract will not allow retention of protected retirement age, or scheme specific protected tax free cash).
The Pension Schemes (Transfers, Reorganisations and Winding-Up (Transitional Provisions) Order 2006 (S.I 2006/573 as amended by The Pension Schemes (Transfers, Reorganisations and Winding-Up (Transitional Provisions) (Amendment) Order 2010 (S.I. 2010/529)
Tax-free cash and Section 32s
Tax-free cash is similar to that of any other registered pension scheme (see our article Pension Commencement Lump Sum Tax Free Cash) unless the individual was entitled to a larger lump sum under their previous scheme as at 5 April 2006.
If this is the case, the tax-free cash would be the value of the lump sum that could have been paid had the individual become entitled to it on 5 April 2006. This is based on an assumption that the member is in good health and no reduction for early payment applies. This figure is subject to the maximum tax-free cash allowable under HMRC rules before 6 April 2006.
The Section 32 must guarantee to pay at least the GMP from the previous scheme at age 60/65 (due to the way the legislation is written, even though State Pension age is increasing, the age for GMP stays at 60 for females and 65 for males).
The Section 32 provider must make up any shortfall to pay the GMP amount due.
As such, if the fund value doesn’t cover the GMP revalued to age 60/65, transfer and early retirement can be prevented.
Section 32s and pension flexibility
The availability of options at crystallisation will be determined by the scheme rules*. If a S32 plan holder requires access to flexibility and it’s not offered by the current scheme, they may need to consider transferring the benefits to a scheme that offers the required options (assuming the trustees of the current scheme are prepared to offer a transfer). However, this may have an impact on any protected retirement age and protected tax-free cash, and result in the loss of the safeguarded benefit provided by any GMP element retained within the scheme.
*Please note, whilst scheme rules may not allow all HMRC pension freedom payment options, the trustee/ administrator may choose to use a permissive override allowed by HMRC (Finance Act 2004, Section 273B). This is not mandatory and any scheme may be unwilling or unable (perhaps due to system/ plan constraints) to apply the override.
Where the override is applied, this effectively permits the scheme to make certain payments allowed by HMRC even where the scheme rules are more restrictive and would prevent such payments. For example, “blink of an eye” drawdown may be possible, so that the protected tax free cash (for example) could be paid by the scheme with the balance of fund being ‘notionally’ designated to drawdown. There is no drawdown plan/ contract actually set up in the original scheme but instead an immediate drawdown to drawdown transfer takes place to another pension scheme chosen by the member. The result is the member does not lose out on protection as this transaction meets the condition, applying to pre A-day tax free cash and early pension age protections, which states all benefits must be put in to payment at the same time.
If a S32 member dies before taking all of their benefits, the scheme rules will determine the death benefits which will be offered. One of the usual options would be the value of the plan paid as a lump sum. However, scheme rules can only offer death benefits which are allowed within the legislation, so the amount paid as a lump sum may have to be restricted, eg where GMP benefits are included in the S32 plan.
Any lump sum death benefit, paid within two years of the scheme administrator being made aware of the member’s death, will use the planholder’s personal lifetime allowance (LTA), and any LTA excess charge must be paid by the recipient(s).
GMP benefits may have to be used to provide a pension (payable immediately) to a surviving spouse/ civil partner, on the basis determined within legislation. It may be possible to commute this for a lump sum payment instead depending on its value. This type of payment does not use any LTA.
If there is no surviving spouse/ civil partner, scheme rules may allow a lump sum to be paid to the deceased’s legal personal representatives or, in some cases, a valid trust set up by the planholder before their death.
It is generally considered that lump sum death benefits paid under discretionary trusts (set up whilst the member is in good health), will not form part of the member’s estate for Inheritance Tax (IHT) purposes. However, if lump sum death benefits arising from contracting-out benefits are not paid under discretionary powers, these will form part of the deceased’s estate for IHT purposes.