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Tax-free cash and the lifetime allowance rules

With lifetime allowance protection, as well as scheme protected tax-free cash, there are now many different ways in which an individual’s maximum tax-free cash (TFC) might be calculated.  This article is designed to summarise the calculations for each circumstance.

These are not comprehensive notes.

 Under the pension legislation introduced on 6 April 2006 the general rule for the provision of tax-free cash from a registered pension scheme is that the maximum tax free cash (TFC) an individual can take in their lifetime may not exceed 25% of the individual's lifetime allowance. 

This rule is applied by limiting the TFC available at each benefit crystallisation event (BCE) to the lower of: (i) 25% of the individual’s available lifetime allowance; or (ii) 25% of the value being crystallised at the BCE.  An individual’s available lifetime allowance may be based on the standard lifetime allowance, or a protected lifetime allowance such as Fixed Protection. However, many people had accrued a tax free cash entitlement under the old pension legislation that exceeded 25% of the fund value, and rules were introduced to protect affected individuals, either by way of protection of the larger TFC entitlement within a particular pension scheme, or by way of protection of a larger TFC entitlement by way of lifetime allowance protection (Enhanced Protection, or Primary Protection).

Protected TFC via Scheme Protection

Many people had built up an entitlement to TFC that was greater than 25% in a particular pension schem higher amount.e prior to the inception of Pension Simplification on 6 April 2006. In order for these members not to be disadvantaged by the new pension rules, legislation was introduced to protect this level of TFC within their pension schemes going forward until benefits were taken. There were certain restrictions on how this protection would be maintained when pension rights are transferred between schemes (block transfers and scheme wind ups).

The protected TFC available at A Day is recorded by the scheme as a monetary amount.

When the member subsequently decides to take their pension benefits the amount of TFC that can be paid will be calculated at that point. There are two elements to this calculation:

  • Revalue the A-Day protected cash value by 20%, and
  • Calculate an additional lump sum allowance (ALSA), which is 25% of the growth in pension rights since A-Day as calculated by a specific formula.  

The formula for the calculation of the additional lump sum amount (ALSA) is:

ALSA = A – (B x C / D) where:

  • A is the current value of the member’s rights in the scheme (e.g. the current fund value in a money purchase pension scheme);
  • B is the value of the member’s rights in the scheme on 05/04/2006 (e.g. the fund value on that date in a money purchase pension scheme);
  • C is the current lifetime allowance; and
  • D is £1.5m, the value of the lifetime allowance on 06/04/2006

The value used as current lifetime allowance in the formula above depends on the type of lifetime allowance (LTA) protection the individual has, as detailed below.

Individuals with no LTA protection (also includes individuals with Enhanced Protection or Primary Protection, where those protections do not also offer the individual TFC protection)

Current LTA will be a value of £1 million.

Individuals with Fixed Protection 2012

Current LTA will be a value of £1.8 million

Individuals with Fixed Protection 2014

Current LTA will be a value of £1.5 million

Individuals with Fixed Protection 2016

Current LTA will be a value of £1.25 million

Individuals with Individual Protection 2014

Current LTA will be their individual protection lifetime allowance, which will be a value between £1.25m and £1.5m

Individuals with Individual Protection 2016

Current LTA will be their individual protection lifetime allowance, which will be a value between £1m and £1.25m

Examples: 

An individual has a money purchase pension with an A Day protected TFC sum of £80,000 and an A Day fund value of £200,000. The individual is looking to take his benefits in the tax year 2016/17 with a standard LTA of £1 million and a current fund value of £300,000.

The calculation of the maximum TFC that can be paid to the individual will be done in 2 parts:

1. Increase A Day TFC sum of £80,000 by 20%. The result is £96,000;
2. Calculate ALSA. The calculation of ALSA will be different, depending on the type of lifetime allowance the individual has:

No protection (also includes individuals with Enhanced Protection or Primary Protection, where those protections do not also offer the individual TFC protection):
ALSA = £300,000 - (£200,000 x £1m/£1.5m) x 0.25 = £41,666

Fixed protection 2012:
ALSA = £300,000 - (£200,000 x £1.8m/£1.5m) x 0.25 = £15,000

Fixed protection 2014:
ALSA = £300,000 - (£200,000 x £1.5m/£1.5m) x 0.25 = £25,000

Fixed protection 2016:
ALSA = £300,000 - (£200,000 x £1.25m/£1.5m) x 0.25 = £33,333

Individual Protection 2014 or 2016:
The calculations will be as above with the client using their personalised individual protected amount.
ALSA = £300,000 - (£200,000 x Individual LTA/£1.5 million) x 0.25 = £----

The maximum TFC available to the member will be £96,000, plus the calculated amount of ALSA. For example, if the individual had Fixed Protection 2012, their maximum TFC would be £110,100 (£96,000 plus £15,000).

Protected TFC via Enhanced Protection

Any client who has Enhanced Protection whose entitlement to TFC from all schemes on 05/04/2006 was greater than £375,000 will have that entitlement recorded on their Enhanced protection certificate as a percentage. The percentage figure recorded will identify the amount that can be taken as TFC from each scheme held by this client.

Subsequent changes in the LTA have no effect on this entitlement.

 

Protected TFC via Primary Protection

Protected TFC under Primary Protection was given as a monetary amount on any Primary Protection certificate that was issued. If there was no monetary amount stated no protection had been granted. Any monetary amount would have been increased in line with the increase with the LTA and this will apply to the LTA increases up to £1.8 million. However, due to the consequences of the changing legislation this TFC value may vary depending on circumstances and may be revalued.

First BCE and TFC sum paid after April 2014
The available TFC figure stated at A Day will be increased in line with the increase in the LTA to £1.8 million (i.e. increased by 20%.
Example: TFC at A Day of £500,000 would be increased by 20% so £500,000 x 1.2 = £600,000).

Previous BCE with TFC and next BCE after April 2014
In these circumstances you will still enhance the original monetary amount by 20%. However, for the pre April 2014 monetary sum taken as TFC you will apply the formula of; £1.8/the LTA applicable at the point of the calculation. Once this calculation has been done (providing a slightly larger TFC monetary amount), this sum will be taken away from the original protected monetary amount increased by 20% and this will give you the available TFC sum left for any future TFC payments.

Example – A client has a protected TFC amount under Primary Protection of £500,000 and is looking to encash £1 million. He had previously encashed £250,000 in tax year 2008/09 when the standard LTA was £1.65 million and took TFC of £100,000. To discover what his remaining TFC entitlement is we need to revalue the original TFC taken based on the calculation above, so £100,000 x £1.8 million/£1.65 million = £109,090.90. So the remaining TFC available is £6500,000 - £109,090.90 = £390,909.10.

These calculations will have to be done for each event the client has where TFC is being taken. The formula will always start with the figure of £1.8 million until such time as the LTA exceeds this figure in the future.

Enhanced and/or Primary Protection with no Protected TFC

For individuals with Primary or Enhanced Protection and no TFC protection, the maximum TFC will be the lower of: (i) 25% of the amount crystallised at a retirement BCE; and (ii) 25% of their available lifetime allowance, based on an applicable lifetime allowance of £1.5 million for this purpose.
To calculate their available lifetime allowance, first any amounts of lifetime allowance used up (crystallised) when benefits were previously taken (a prior event) are identified.
Next, those values are adjusted to take into account changes in the standard lifetime allowance over time. This adjustment is made using the formula:

  • Amount crystallised at prior event x (CSLA x PSLA)

In the above, the value used as CSLA and PSLA depends on the date of the prior event.
If the prior event took place between 06/04/2006 and 05/04/2014 inclusive, then:

  • CSLA is the current standard lifetime allowance; and
  • PSLA is the standard lifetime allowance at the time of the prior event

However, if the previous event took place on/after 06/04/2014, then:

  • CSLA is the greater of: (i) the current standard lifetime allowance; and (ii) £1.5m; and
  • PSLA is the greater of: (i) the standard lifetime allowance at the time of the prior event; and (ii) £1.5m

Finally, the adjusted amounts are deducted from £1.5m to determine the available lifetime allowance for the purposes of the 25% maximum lump sum rule.

Fixed and Individual Protection

The principle of the TFC available at each benefit crystallisation event (BCE) being the lower of (i) 25% of the individual’s available lifetime allowance, or (ii) 25% of the value being crystallised at the BCE applies. The individual’s lifetime allowance protection will determine the lifetime allowance on which their available lifetime allowance will be based. For:

  • Fixed Protection 2012, their available lifetime allowance will be based on £1.8 million;
  • Fixed Protection 2014, their available lifetime allowance will be based on £1.5 million;
  • Fixed Protection 2016, their available lifetime allowance will be based on £1.25 million;
  • Individual Protection 2014 or 2016, their available lifetime allowance will be based on their individual protection lifetime allowance.

 

Summary Table

 

  Maximum Tax Free Cash Available

No LTA protection, no TFC protection

The lower of 25% of the member’s scheme rights, and 25% of their unused standard Lifetime Allowance.
Enhanced LTA – Pension Credit, overseas enhancement, transfer from Overseas schemes The lower of 25% of the member’s scheme rights, and 25% of the unused standard Lifetime Allowance.
Primary Protection/Enhanced Protection but no TFC protection The lower of 25% of the member’s scheme rights, and 25% of their unused Lifetime Allowance (Lifetime Allowance is £1.5m for this purpose).

Primary Protection with TFC protection

A Day protected cash amount increased by 20%, minus the adjusted value of any lump sum already taken.
Enhanced Protection with TFC protection The percentage of the member’s scheme rights detailed on the enhanced protection certificate.
Fixed Protection 2012 The lower of 25% of the member’s scheme rights, and 25% of their unused Lifetime Allowance (Lifetime Allowance is £1.8m for this purpose).
Fixed Protection 2014 The lower of 25% of the member’s scheme rights, and 25% of their unused Lifetime Allowance (Lifetime Allowance is £1.5m for this purpose).
Fixed Protection 2016 The lower of 25% of the member’s scheme rights, and 25% of their unused Lifetime Allowance (Lifetime Allowance is £1.25m for this purpose).
Individual Protection 2014 or 2016 The lower of 25% of the member’s scheme rights, and 25% of their unused Lifetime Allowance (Lifetime Allowance is their individual protection lifetime allowance for this purpose).
Scheme Specific Lump Sum protection The lesser of the scheme revalued protected tax free cash* and the member’s remaining lifetime allowance**, but note that it will not be possible for the individual to take the entire value of their pension rights as a tax free lump sum unless it is a stand alone lump sum.


* If revalued protected tax free cash exceeds the value of the pension fund a small amount of the fund must be used to provide a pension benefit which could itself be taken as a trivial taxable lump sum.
** For the purpose of determining whether there is any remaining lifetime allowance to pay the protected tax free cash lump sum the remaining lifetime allowance is their based on their personal lifetime allowance which may be more than the standard lifetime allowance.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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