Ordinary tax-free cash protection for individuals with more than one scheme

These FAQs are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of legislation at the date of publication.

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Overview

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% on 5 April 2006. If so, the scheme can record the tax-free cash entitlement as at 5 April 2006, and pay out a higher amount of ‘protected tax-free cash’ (as an authorised payment) than the tax rules post-5 April 2006 would normally allow. 

This is straightforward if there is only one policy for an individual that has a protected tax-free cash amount. However, what is the situation at 5 April 2006 where an individual with protected tax-free cash was a member of more than one OPS for the same employment? 

There will only be one protected tax-free cash amount at 5 April 2006 for the individual’s employment but how you do you make sure that the correct amount of tax-free cash is allocated to each scheme? This is covered in the rest of these FAQs. 

What if someone is a member of more than one scheme for the same employment? 

Each occupational pension scheme (OPS) should be looked at separately at 5 April 2006 to assess what tax-free cash is available from each, before arriving at the overall tax-free cash the individual is entitled to. The best way to demonstrate the way it works is to use an example.

Example

Robert has three separate money purchase occupational pension schemes in respect of the same employment. The total fund value is £500,000, split as follows:

OPS1 = £250,000

OPS2 = £150,000

OPS3 = £100,000

The maximum tax-free cash for the employment was calculated as £130,000 based on salary and service up to 5 April 2006. All three schemes allow tax-free cash up to HMRC’s maximum for service up to 5 April 2006.

The maximum tax-free cash at 5 April 2006 should be calculated as:

Scheme Fund value at 5 April 2006 Maximum tax-free cash
OPS1 £250,000 £130,000
OPS2 £150,000 £130,000
OPS3 £100,000 £100,000 (capped at fund value)
Total £500,000 £360,000

As the total aggregated tax-free cash of £360,000 is £230,000 more than the HMRC maximum tax-free cash of £130,000, the amount of tax-free cash that can actually be paid must be reduced proportionately across all schemes. This is done as follows

Scheme Fund at 5 April 2006 Tax-free cash Tax-free cash as a % of fund Required reduction Final tax-free cash amount Final tax-free cash %
OPS1 £250,000 £130,000 52% (£230k x £130k)/£360k = £83,056 £130,000 - £83,056 = £46,944 18.77%
OPS2 £150,000 £130,000 86.67% (£230k x £130k)/£360k = £83,056 £130,000 - £83,056 = £46,944 31.29%
OPS3 £100,000 £100,000 100% (£230k x £100k)/£360k = £63,888 £100,000 - £63,888 = £36,112 36.11%

In effect, the formula for calculating the final tax-free cash amount is:

Scheme lump sum – (excess lump sum x scheme lump sum/total lump sums)

The resultant figures show that the tax-free cash of £46,944 available from OPS1 is less than 25% of the fund value. This amount can therefore be increased to 25% so that actual tax-free cash payable is £62,500. The overall tax-free cash is increased from £130,000 to £145,556 as a result.

For this example, OPS1 will have a 25% tax-free cash entitlement, whereas OPS2 and OPS3 will have protected tax-free cash entitlements at 5 April 2006. 

Summary of the calculation process

In summary, the steps to calculate the overall tax-free cash at 5 April 2006, where there is more than one occupational scheme relating to the same employment are:

Step 1:

Calculate the tax-free cash for each scheme as at 5 April 2006. This will produce a cash amount per scheme, which should be the lowest of:

  1. the cash amount allowed under the scheme rules,
  2. the HMRC maximum tax-free cash amount, and
  3. the actual fund value

Step 2:

Add up the tax-free cash amounts and compare this to the HMRC maximum tax-free cash amount for the employment

Step 3:

If the total tax-free cash figure is higher than the HMRC maximum tax-free cash, then the cash amount per scheme (calculated in step 1) should be proportionately reduced to make the total equal to the HMRC maximum.

Step 4:

If the tax-free cash amount under any scheme is less than 25% of the fund value, then the actual amount payable under that scheme can be increased to 25%. This can result in the overall pre 6 April 2006 HMRC maximum tax-free cash amount being exceeded.

Although the example used here is for someone who is a member of more than one money purchase occupational pension scheme, the same approach should be used for an individual who has, for example, a section 32 buyout, an assigned policy and an occupational pension scheme for the same employment.

Further information

You can find out more about this in HMRC’s Pensions Tax Manual(Opens new window).

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