Tax Free Cash

The maximum tax-free cash that is normally available from a registered pension scheme is the lesser of:

• 25% of the value of the pension benefits, or
• 25% of the member's remaining lifetime allowance (even where the member is entitled to an enhanced lifetime allowance) 

Tax-free cash can be higher (or lower) than this where:

1. the member has tax-free cash protection (also known as scheme specific tax-free cash protection)
2. the total value of an individual’s crystallised and uncrystallised lump sum rights on 5 April 2006 was more than £375,000 and that individual had registered their tax-free cash entitlement along with their enhanced and/or primary protection.
3. where some or all of an individual’s fund comes from a disqualifying pension credit. No tax-free cash is allowed from the portion in respect of a disqualifying pension credit.

In this section, we cover the first bullet point – tax-free cash protection.

The tax-free cash entitlement under an occupational pension scheme (OPS), an assigned occupational policy or a section 32 buyout policy (s32) could have been greater than 25% when the pension tax rules changed on 5 April 2006. If that applied, the scheme can record the tax-free cash entitlement as at 5 April 2006, and pay out a higher amount of tax-free cash (as an authorised payment) than the tax rules post-5 April 2006 would normally allow.

Protected tax-free cash can be relevant for an individual with:

• No fund protection
• Enhanced or primary protection with no registered tax-free cash entitlement
• Fixed protection 2012, 2014 or 2016
• Individual protection 2014 or 2016

There’s no requirement for a scheme or a scheme member to register for protected tax-free cash with HMRC, as the legislation applies protection automatically.

A member must crystallise their pension benefits from the scheme in full to keep their protected tax-free cash (PTFC) entitlement - any partial vesting of benefits would result in the member losing the PTFC entitlement. The amount payable will be the value of:

• the PTFC on 5 April 2006, revalued to the date of taking pension benefits (see note below), plus
• 25% of the ‘post-5 April 2006’ fund value 

Note in tax year 2011/12, the PTFC on 5 April 2006 was revalued by 20% to reflect the increase in the SLA from £1,500,000 in 2006/07 to £1,800,000 in 2011/12. The SLA has been reduced several times since then and is now £1,073,100 (from tax year 2023/24) but the 20% increase will continue to apply until the SLA increases above £1,800,000.

In the tax year 2023/24, here’s how to calculate PTFC:

PTFC on 5/4/06 x (£1.8m* / £1.5m) 

PLUS

25% x [current fund value - {fund on 5/4/06 x (£1.0731m / £1.5m)}]

*Remember, this figure is based on the greater of £1,800,000 and the current SLA (£1,073,100 for tax year 2023/24).

Any negative value resulting from the calculation of the ‘post-5 April 2006’ value should be taken as zero.

Example:

Bill has no fund protection and no registered tax-free cash entitlement with enhanced or primary protection. He had PTFC of £80,000 and a fund of £120,000 on 5 April 2006. On crystallising pension benefits in May 2023, the value of his fund had increased to £160,000.

Bill's tax-free cash in May 2023 is calculated as:

£80,000 x (£1.8m/£1.5m) = £96,000

PLUS

25% x [£160,000 - {£120,000 x (£1.0731m / £1.5m)}] =  £18,538

Bill’s protected tax-free cash amount is £96,000 + £18,538 = £114,538

To help minimise the effects of the reductions in the SLA from £1.8million to £1.5 million on 6 April 2012, then to £1.25 million on 6 April 2014, and then to £1 million on 6 April 2016, HMRC has introduced various protections – fixed protection (FP) 2012, 2014 and 2016 and individual protection (IP) 2014 and 2016. You’ll find more information on these fund protections under a separate Fund Protection Guide.

Where the individual also has protected tax-free cash, the relevant fund protection will affect the calculation of the ‘post-5 April 2006’ value, as the fund on 5/4/06 will be revalued using the greater of the individual's protected LTA and the current SLA (£1,073,100 in 2023/24).

FP2012 will fix an individual's LTA at £1,800,000, FP2014 will fix it at £1,500,000 and FP2016 will fix it at £1,250,000.  Where individual protection applies, the individual's LTA will be the aggregate value of their pension savings at the date relevant to the type of protection applied for, subject to a cap.   The caps are £1,500,000 for IP2014 and £1,250,000 for IP2016.

Here's how PTFC is calculated where someone has one of these fund protections.  

PTFC on 05/04/06 x (£1.8m / SLA in 2006/07)

PLUS

25% x [current fund value - {fund on 5/4/06 x (greater of the protected LTA and the current SLA / SLA in 2006/07)}]

Example: Taking benefits with FP2012

Jill applied for FP2012 fixing her LTA at £1,800,000. One of her pension schemes has PTFC of £80,000 and a fund of £120,000 on 5 April 2006. On crystallising the fund in May 2023, its value had increased to £160,000.

Jill’s tax-free cash in May 2023 is calculated as:

£80,000 x (£1.8m / £1.5m) = £96,000

PLUS

25% x [£160,000 - (£120,000 x £1.8m / £1.5m)] = £4,000

Jill's protected tax-free cash amount is £96,000 + £4,000 = £100,000

If you were to repeat this calculation for FP2014, FP2016, IP2014 and IP2016, in tax year 2023/24, you would get the following figures:

Any registered tax-free cash of over £375,000 in connection with primary protection will take precedence over any protected tax-free cash. So, protected tax-free cash would only apply if a person loses or gives up their primary protection.   

Similarly, any registered tax-free cash of over £375,000 in connection with enhanced protection will take precedence over any protected tax-free cash and any registered tax-free cash of over £375,000, for those with dormant primary protection.  

For those with enhanced and/or primary protection who don’t have registered tax-free cash of over £375,000, any protected tax-free cash that they have will operate as normal.

A tax-free cash entitlement of 100% of the final fund value can only be paid where it is a ‘stand-alone lump sum’ (see the section of this guide on Stand Alone Lump Sums). Otherwise, to be an authorised payment, tax-free cash must be paid in connection with an actual entitlement to a relevant pension benefit. This can be a lifetime annuity, a scheme pension or a flexi-access drawdown pension (including nil income flexi-access drawdown pension).

If, when a member takes pension benefits, the current fund value exceeds the protected tax-free cash (PTFC) by £10,000 or less it may be possible to pay the residual fund as a trivial lump sum – see the section titled ‘What are the conditions for a trivial lump sum?' below.

If the PTFC exceeds the current fund value, the full PTFC can’t be paid as a minimum fund must be allocated to provide a relevant pension benefit. If the allocated fund is £10,000 or less, it may be paid as a trivial lump sum as shown in the following example. 

Example: protected tax-free cash exceeds the fund value

Bob is 62 and has protected tax-free cash of £50,000 and the current fund value of Bob’s pension plan is £40,000. The scheme rules allow a minimum fund of £1,000 to be allocated to provide a pension. This means Bob will receive PTFC cash of £39,000 and can take the £1,000 as a trivial lump sum.

Some providers may also allow another workaround. A drawdown plan is set up for a minimum amount of say £1 with the remaining funds being paid out as protected tax-free cash (assuming this is equal or less than the member’s protected tax-free cash amount). The £1 is then taken as an admin charge which leaves a nil value in the drawdown plan

When a member takes their PTFC, the residual fund can be taken as a trivial lump sum where it has a commuted value of £10,000 or less. The following conditions must also be met.

• the member is age 55 or over (unless they meet the ill health condition or have a protected pension age.)
• the member has some of their lifetime allowance remaining after payment of the PTFC. For this purpose, benefit crystallisation events 5 and 5B are ignored when the member is age 75 or over.
• the trivial lump sum payment will extinguish the member’s entitlement to all benefits under the scheme, excluding any pension that was already in payment before 6 April 2006.
• the trivial lump sum is paid no later than one month after the PTFC is paid.
• since the PTFC was paid, in respect of the member:
  • no contributions have been made to the scheme
  • no recognised transfer (for example, a transfer from one registered pension scheme to another) has been made into or out of the scheme
  • no scheme funds have been used to buy an annuity or scheme pension

The trivial lump sum will be subject to the member's marginal rate of tax. Payment of the trivial lump sum is not classed as a benefit crystallisation event.

This trivial lump sum rule can be applied independently to any scheme under which the member has protected tax-free cash. 

A member can transfer their pension benefits to another registered pension scheme and protect their protected tax-free cash entitlement but only if they meet certain conditions.

The conditions that must be met depend on the type of scheme currently holding the benefits and the type of scheme accepting the transfer, and these are:

• a member in a S32 (regardless of whether it was taken out pre-6 April 2006 or post-5 April 2006) can protect their tax-free cash on transfer to another S32 if the original S32 is winding up. Subsequent transfers to another S32 on winding up would also retain the protected tax-free cash.
• members of a registered pension scheme who transfer as part of a block transfer (two or more members moving from the same scheme at the same time to the same receiving registered pension scheme) will protect their tax-free cash, provided certain conditions are met under the block transfer rules – see the section below titled ‘What are the block transfer rules?’.
• a member of a registered pension scheme can transfer to a S32 (individual or trustee-proposed) and protect their tax-free cash entitlement provided the scheme is winding up. A subsequent transfer to another S32 on wind-up would also retain the tax-free cash protection.
• Where a policy has been assigned to a member, the tax-free cash can be protected on transfer to a S32. A subsequent transfer on wind-up would retain the tax-free cash protection. 

A tax-free cash entitlement for a member of a scheme that winds up is protected on transfer to a s32, whether this is to an individual s32 or a trustee-proposed s32 (TPS32). It is also possible for any subsequent transfers to a s32 to retain protected tax-free cash.

If the scheme winding up is a one-man occupational pension scheme then protection is only available on transfer to a s32 (either individual or trustee-proposed). A block transfer is not an option as there is no ‘buddy’ to transfer with.

Members who have their policy assigned to them (rather than having benefits transferred to a s32) on scheme wind-up will have the same protection for their tax-free cash entitlements as those whose benefits are transferred to a s32. 

Protected tax-free cash will be lost if:

• the member doesn’t take all the benefits from the pension scheme at the same time, or
• the member transfers their benefits to another pension scheme after 5 April 2006 unless it is a block transfer, or
• the scheme is winding up and the benefits are not either:
  • transferred to a s32, or
  • assigned to the member

Where tax-free cash protection is lost, the member’s tax-free cash will be calculated on the standard basis (normally, the lower of 25% of the fund value or 25% of the member's remaining standard lifetime allowance). 

Protected tax-free cash will be reduced if:

• there is insufficient lifetime allowance available at when benefits are taken to cover the full amount of tax-free cash entitlement (any excess paid over the lifetime allowance as a lump sum would be subject to income tax at the member’s marginal rate), or
• the fund value when benefits are taken isn’t sufficient to cover the full amount, or
• the member makes a partial transfer from the scheme holding the protected tax-free cash; in this case, the protected tax-free cash entitlement will be reduced by 25% of the amount transferred out 

Note that there is no requirement to reduce a member’s protected tax-free cash following the payment of a pension share as a result of divorce proceedings. This is because the pension share is not regarded as a partial transfer for the purpose of the tax-free cash protection conditions.

A block transfer can protect members’ tax-free cash entitlement on 5 April 2006 provided certain conditions are met. The rules required for a transfer to be a block transfer under which tax-free cash protection will be maintained are:

1. all the member’s benefits under the transferring scheme must be moved in a single transaction to one other scheme
   • Split transfers are not permitted.
2. all the benefits of at least two members must be transferred to the same receiving scheme at the same time
   • Not all members involved in the block transfer need to be seeking protection. One or more can simply act as a ‘buddy’ to provide protection for another member.
   • The transfers do not have to be passed to the receiving scheme on the same day as long as they are received within a reasonable timescale in relation to the agreement to transfer.
3. any member involved in the block transfer who is seeking protection for tax-free cash must not have been a member of the receiving scheme for more than 12 months at the time of transfer
   • This can be ignored for a ‘buddy’ who is not seeking protection for tax-free cash.
   • Where an existing membership relates only to a rebate-only personal pension plan that started before 6 April 2006, this can be ignored for the 12-month rule.
   • As tax-free cash protection is scheme-wide, membership in respect of any other arrangement under the same scheme would be taken into account. So if, for example, someone had set up a Personal Pension under the receiving scheme six years ago, this would mean the 12-month condition could not be met and tax-free cash on transfer would not be protected.
4. the member must become entitled to all of their pension and lump sum rights under the scheme on the same day
   • Benefits taken before 6 April 2006 can be ignored.
   • If other benefits had been taken by the member since 6 April 2006 and before the protected tax-free cash transfer was paid in, the protection would be lost (as not all benefits under the scheme would have been taken at the same time).
5. a scheme can only provide protection for one amount of protected tax-free cash
   • Any subsequent protected tax-free cash amounts transferred in would be invalid. This situation can be avoided by making sure protected tax-free cash amounts for a member are applied to different receiving schemes.

Block transfer payments cannot be made to a s32 policy. S32 policies are individual contracts and each is a registered pension scheme in its own right. Consequently, the condition that there must be a block transfer of two or more members to the same receiving scheme cannot be met.

When tax-free cash is being protected on transfer, the main information that needs to be passed from the transferring scheme to the receiving scheme is:

• The fund value at 5 April 2006
• The protected tax-free cash amount at 5 April 2006

When a transfer is accepted into the receiving scheme, care needs to be taken in making sure these figures are accurate and look sensible, particularly where the transferring scheme is a defined benefits (DB) scheme. The transferring DB scheme may only provide an accrued pension figure at 5 April 2006 rather than a fund value so extra work may need to be carried out by the receiving scheme to calculate a notional fund value at 5 April 2006. 

For example, assume that a transferring DB scheme confirms that the transferring member has protected tax-free cash and provides the following information as part of a transfer to a personal pension:

Accrued pension at 5 April 2006 = £4,000pa

Tax-free cash at 5 April 2006 = £25,000

The receiving scheme will need to convert the accrued pension to a notional fund value at 5 April 2006 and they should do this using a factor of 20 to 1. So, the accrued pension of £4,000pa would equate to a notional fund value of £80,000 at 5 April 2006. The member’s protected tax-free cash of £25,000 is therefore 31.25% of the £80,000 notional fund value at 5 April 2006. The receiving scheme should note £80,000 as the fund value at 5 April 2006 and £25,000 as the protected tax-free cash amount at 5 April 2006.

Summary of the effect of transferring between different types of schemes

The table below shows the impact on tax-free cash protection when transferring between different types of schemes. As the table shows, it’s possible to transfer benefits more than once and retain the protected tax-free cash provided the relevant conditions are met.

Further information

You can find more information on protected tax-free cash at: