This guide is for financial advisers only. It mustn’t be distributed to, or relied on by, customers. It is based on our understanding of legislation as at May 2023.
Normally, tax-free cash can only be paid where there is an entitlement at the same time to either a lifetime annuity, scheme pension or drawdown pension. For this reason, it’s not possible for all of a member’s rights under a pension scheme to be paid as tax-free cash. However, some individuals may have had an entitlement on 5 April 2006 under an approved occupational pension scheme to take 100% of their fund as tax-free cash.
To recognise this, and to allow protection of these 100% tax-free cash amounts in certain circumstances, HM Revenue & Customs (HMRC) introduced the concept of the ‘stand-alone lump sum’. Conditions must be met for ‘stand-alone lump sum’ protection to apply, and these are explained below.
To be classed as a stand-alone lump sum, the lump sum entitlement must meet a number of conditions:
- an individual must have reached the normal minimum pension age of 55 or, if retiring earlier, have a protected pension age or be taking benefits due to ill-health.
- all of an individual’s uncrystallised rights under the scheme must be paid at the same time.
- if an individual has registered tax-free cash of more than £375,000 alongside primary protection, then the stand-alone lump sum must represent a 100% tax-free cash entitlement as at 5 April 2006 under a registered pension scheme. (Where someone has registered tax-free cash of more than £375,000 with primary protection, a monetary amount of lump sum is protected across all the schemes the individual is a member of and this amount will be quoted on their primary protection certificate. Individuals can then choose, subject to scheme rules, the amount of lump sum they take from each scheme. So, an individual may take all the benefits from a particular scheme as a stand-alone lump sum, where the rules of the scheme allow this.)
- if an individual has registered tax-free cash of more than £375,000 alongside enhanced protection, all of their approved pension benefits if they had retired on 5 April 2006 could have been paid as tax-free cash. For this purpose, it should be assumed that the individual was in good health and no early retirement factors applied. (Where someone has registered tax-free cash of more than £375,000 with enhanced protection, their enhanced protection certificate will quote the maximum percentage of tax-free cash available every time benefits are taken.)
- if the protection for tax-free cash is scheme specific only (in other words, the individual does not have registered tax-free cash of more than £375,000 alongside either primary or enhanced protection), then;
- had the member retired on 5 April 2006, all of their benefits under approved occupational pension schemes (including section 32 buyout policies) relating to that employment could have been paid as tax-free cash. This is on the assumption that the member was in good health and no early retirement factors applied.
there must have been no ‘relevant benefit accrual’ under the scheme paying the stand-alone lump sum on or after 6 April 2006. Generally, for a money purchase scheme this means no contributions have been paid, and for a defined benefit scheme that any increase in benefit value is within the ‘appropriate limit’. The following guidance from HMRC provides further information on what the appropriate limit is:
The maximum stand-alone lump sum that can be paid varies depending on whether the member has primary protection and registered tax-free cash, enhanced protection and registered tax-free cash or scheme-specific tax-free cash protection.
Member has primary protection and registered tax-free cash
The maximum stand-alone lump sum that can be paid is:
- the value of the unvested lump sum rights as at 5 April 2006, increased in line with the standard lifetime allowance*, less
- any tax-free cash already paid to the member since 6 April 2006, with each such payment being increased in line with increases in the standard lifetime allowance from the date the tax-free cash was paid*.
*Note that although the standard lifetime allowance has decreased to £1,073,100 from £1,500,000 in 2006/7, for the purpose of increasing in line with the standard lifetime allowance, it is assumed to be currently £1,800,000. This will currently mean a 20% increase (£1,800,000/£1,500,000 x 100%). If the standard lifetime allowance increases above £1,800,000, the actual standard lifetime allowance will be used again.
Member has enhanced protection and registered tax-free cash, or scheme-specific tax-free cash protection
The maximum stand-alone lump sum that can be paid is:
- for a money purchase scheme, it’s the value of the fund – this means the stand-alone lump sum can include any investment growth since 6 April 2006. That is, there is no link to the standard lifetime allowance.
- for a defined benefit scheme, it’s the 5 April 2006 value increased to the ‘appropriate limit’ that applies to enhanced protected defined pension benefits. The following guidance from HMRC confirms what the appropriate limit is.
It is worth remembering that for a stand-alone lump to be paid in either of the above circumstances, there must have been no relevant benefit accrual since 6 April 2006, or payment of any contribution to a money purchase scheme. This would cause the member to lose their enhanced protection. An increase in benefit value above the appropriate limit under a defined benefit scheme would be classed as relevant benefit accrual.
Payment of a stand-alone lump sum is a benefit crystallisation event falling within benefit crystallisation event 6 if it occurs before age 75. If benefits are still uncrystallised at age 75, then they are deemed to be crystallised for lifetime allowance purposes at that time.
Where a member has used up 100% of their lifetime allowance and doesn’t have enhanced protection, any excess amount of the stand-alone lump sum will be taxed at their marginal rate for the 2023/24 tax year.
Primary protection with registered tax-free cash
The right to a stand-alone lump sum will not be lost on transfer between registered pension schemes.
Enhanced protection with registered tax-free cash
The right to a stand-alone lump sum will not be lost on transfer, although care should be taken to ensure that the rules relating to the transfer being a ‘permitted transfer’ are met.
This is defined in HMRC guidance at:
Scheme-specific tax-free cash protection
The right to a stand-alone lump sum can be protected on transfer in the following circumstances:
- on block transfer to another registered pension scheme. However, if the member has other accrued benefits under the receiving scheme or does not already have a right to a stand-alone lump sum under the receiving scheme, the right to the stand-alone lump sum will be lost in respect of the transferred benefits.
- on occupational scheme wind-up, where benefits are being transferred to a buyout contract or assigned to the individual.
It is also possible for a transfer to be made into a scheme where there is already a stand-alone lump sum entitlement. The right to a stand-alone lump sum under the receiving scheme would be lost if there is a transfer in unless:
- the benefits transferred in consist only of stand-alone lumps sums, and
- no previous tax-free cash or stand-alone lump sum has been paid to the member from the receiving scheme, and
- all of the member’s uncrystallised rights are transferred from the transferring scheme to the receiving scheme.
Where a member has primary protection with registered tax-free cash and takes a stand-alone lump sum from a money purchase arrangement then they will be deemed to have first flexibly accessed their pension rights (if not already) immediately before the payment of the stand-alone lump sum. This means that any contributions made after the payment of the stand-alone lump sum will count towards the MPAA. See the Money Purchase Annual Allowance section of our Annual Allowance guide for further information.
Where a member has enhanced protection with registered tax-free cash or scheme-specific tax-free cash and takes a stand-alone lump sum, then the MPAA will not apply to them, unless it applies already.