Ordinary tax-free cash protection

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

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

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

  1. the member has ordinary 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 these FAQs, we cover the first bullet point – ordinary 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% 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.

Ordinary tax-free cash protection 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 ordinary tax-free cash protection with HMRC.

A member must take 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 amount on 5 April 2006, revalued to the date of taking pension benefits – see note below, plus
  • 25% of the ‘post-5 April 2006’ value 

Note - in tax year 2011/12, the PTFC amount on 5 April 2006 was revalued by 20% to reflect the increase in the standard lifetime allowance (SLA) from £1.5 million in 2006/07 to £1.8 million in 2011/12. The SLA has been reduced several times since then and is now £1 million (tax year 2016/17) but the 20% increase is still used until the SLA increases above the £1.8 million level again. Please note that the current intention is that from 6 April 2018, the SLA will increase in line with CPI. 

This gives a formula of:

(PTFC on 5/4/06 x £1.8m* / SLA in 2006/07) +

(25% x (current value – (fund on 5/4/06 x current SLA / SLA in 2006/07)))

*this is based on the greater of £1.8m and the current SLA (£1 million for tax year 2016/17).

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

 

Example: Bill has either no fund protection or 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 taking pension benefits in March 2017, the value of his pension plan had increased to £160,000.

Bill’s tax-free cash in March 2017 is calculated as: 

(PTFC on 5/4/06 x £1.8m / SLA in 2006/07) 

PLUS 

(25% x (current value - (fund on 5/4/06 x current SLA / SLA in 2006/07))) 

(£80,000 x £1.8m/£1.5m) + (25% x (£160,000 – (£120,000 x £1m/£1.5m))) 

= £96,000 + (25% x (£160,000 - £80,000)) 

= £96,000 + £20,000

= £116,000

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 2016/17, 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 in our FAQs held in the Transitional protection section at:

https://www.aegon.co.uk/advisers/Pensions-technical-zone/transitional-protection.html

Where the individual also has ordinary tax-free cash protection, 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 SLA and the current SLA (£1m in 2016/17).

FP2012 will fix an individual’s SLA at £1.8 million, FP2014 will fix it at £1.5 million and FP2016 will fix it at £1.25 million. Individual protection will fix it at the individual’s personal lifetime allowance (capped at £1.5 million for IP2014 and £1.25 million for IP2016).

The following example shows how the difference in the ‘post-5 April 2006’ fund is calculated where someone has FP2012.  

Example: Taking benefits with FP2012

Jill applied for FP2012 fixing her SLA at £1.8m. One of her pension schemes has PTFC of £80,000 and a fund of £120,000 on 5 April 2006. On taking pension benefits in March 2017 from this fund, its value had increased to £160,000.

Jill’s tax-free cash in March 2017 is calculated as:

(PTFC x (£1.8m / SLA in 2006/07)

PLUS

(25% x (current value - (fund on 5/4/06 x (greater of £1.8m or the current SLA) / SLA in 2006/07)))

(£80,000 x £1.8m/£1.5m) + (25% x (£160,000 – (£120,000 x £1.8m/£1.5m)))

= £96,000 + (25% x (£160,000 - £144,000))

= £96,000 + £4,000

= £100,000

If you were to repeat this calculation for FP2014, FP2016, IP2014 and IP2016, in tax year 2016/17, you would get the following figures:

  Protected amount Revalued PTFC 25% of post 5/4/06 value Total
FP2014 £1.5m £96,000 £10,000 £106,000
FP2016 £1.25m £96,000 £15,000 £111,000
IP2014 £1.4m (assumed value at 5/4/14) £96,000 £12,000 £108,000
IP2016 £1.2m (assumed value at 5/4/16) £96,000 £16,000 £112,000

Any registered tax-free cash of over £375,000 in connection with primary protection for an individual will take precedence over any ordinary tax-free cash protection. So, ordinary tax-free cash protection 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 ordinary tax-free cash protection and any registered tax-free 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 ordinary tax-free cash protection 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’. Otherwise, in order to be an authorised payment, tax-free cash has to be paid at the same time as a pension comes into payment. This can be a lifetime annuity, a scheme pension or a drawdown pension (including nil income 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 pension. 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 ordinary 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 (or younger where 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, BCE 5 and BCE 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 that could reasonably be known about, 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 full trivial lump sum will be subject to basic rate 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 ordinary tax-free cash protection. 

A member can transfer their pension benefits to another registered pension scheme and protect their ordinary 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 on winding-up to another S32 would also retain the ordinary tax-free cash protection.
  • 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 ordinary tax-free cash protection.

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. 

Ordinary tax-free cash protection 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 25% of the fund value, assuming that the member has sufficient lifetime allowance left). 

Protected tax-free cash will be reduced if:

  • there is insufficient lifetime allowance available at vesting 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 a lifetime allowance charge of 55%), or
  • the fund value on vesting 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:

a.    all of the member’s benefits under the transferring scheme must be moved in a single transaction to one other scheme

  • Split transfers are not permitted.

b.    all of 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.

c.    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.

d.    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).

e.    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.

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.

Scheme with protected tax-free cash at 5/04/06 Transfer on or after 6/04/06 to: Retention of tax-free cash possible? Subsequent protected transfer possible?
OPS TPS32, individual s32 or OPS policy assigned to member Yes Providing OPS is winding up Yes To S32 providing the transferring arrangement is winding up
OPS with more than one member Personal Pension (PP) scheme or OPS Yes Providing at least two members transfer to the receiving scheme at the same time as a block transfer Yes Providing at least two members transfer to the same registered pension scheme at the same time
OPS with more than one member Split transfers to two or more PP schemes No Protection is lost as the benefits are not being moved in full from one scheme to another scheme n/a  
OPS with one member (e.g. a one- person EPP) TPS32 or individual s32 or OPS policy assigned to member Yes Providing OPS is winding-up Yes To s32 providing the transferring arrangement is winding up
OPS with one member (e.g. a one- person EPP) PP scheme or OPS No Protection is lost, as only one member is transferring n/a  
Assigned OPS policy Individual s32 Yes Providing the transferring arrangement is winding-up Yes To s32 providing the transferring arrangement is winding up
Assigned OPS policy PP scheme No Protection is lost, as only one member is transferring n/a  
Individual s32 Individual s32 Yes Providing the transferring s32 is winding-up Yes To s32 providing the transferring arrangement is winding up
Individual s32 PP scheme No Protection is lost, as only one member is transferring n/a  
TPS32 Individual s32 Yes Provided the transferring TPS32 is winding-up Yes To s32 providing the transferring arrangement is winding up
TPS32 PP scheme No Protection is lost, as only one member is transferring n/a  

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