We are two brothers who have a limited company and have an executive pension scheme which we stopped paying into some time ago. We have been advised to switch our benefits for various reasons but are concerned about protecting our tax-free cash which represents about 70 per cent of the value of the fund. Our adviser has mentioned something about buddying. How does this work and is this appropriate for us?
The protection of any pre-A-Day tax-free lump sum entitlement on transfer depends on certain conditions being met. The main issue is whether the tax-free lump sum, now known as a pension commencement lump sum (PCLS), has been registered for transitional protection.
Where total PCLS rights over 375,000 as at April 5, 2006 have been registered for primary protection, the registered rights are generally protected if benefits are transferred to another pension scheme.
Where total PCLS rights over 375,000 as at April 5, 2006 have been registered for enhanced protection, the registered rights are generally protected if benefits are transferred to another scheme where the transfer is classed as a permitted transfer.
Where PCLS rights have not been registered for enhanced or primary protection, which would seem to be your case, the protection is scheme-specific and will generally be lost if the benefits are transferred to another pension scheme after April 5, 2006.
There are, however, some exceptions to this general rule. The PCLS rights will generally still be protected on transfer after April 5, 2006 if the transfer is made as part of a block transfer to another registered pension scheme or the transfer is made to a deferred annuity contract (or buyout contract, as they are commonly known) as part of the winding up of the occupational pension scheme.
A block transfer is defined as the transfer, all in one transaction, of more than one member of the transferring scheme to the same registered pension scheme at the same time.
This is where the term “buddy transfer” has been adopted. The transfer must represent the members’ total rights under the scheme and the transfer cannot be split across more than one receiving scheme.
You also need to take into account the fact that the member cannot have been a member of the receiving scheme for more than a year before the transfer or the protection will be lost.
Of course, I am assuming that you have not reached your normal retirement date or are thinking of taking the benefits now.
It should be noted that care also needs to be taken in respect of setting up benefits, so the next question we need to consider is, does phasing in your retirement benefits result in a loss of protected tax-free lump sum rights above 25 per cent of the value of the benefits?
Where the pension commencement lump sum rights (in excess of 375,000 as at April 5, 2006) have been registered for enhanced or primary protection, these rights are not lost if benefits are taken at different times (using phased retirement, for example).
However, under occupational pension scheme-specific protection, PCLS rights above 25 per cent of the value of the benefits can only be paid when the member first takes the benefits – and only if all benefits are taken at the same time.
If benefits are taken at different times (using phased retirement, for example) the right to the protected PCLS is lost. This applies regardless of whether the benefits are taken from the original scheme or from another scheme (such as a personal pension scheme following a block transfer).
It is also important to note that if a transfer is made to a section 32 buyout, any subsequent transfer will reduce the pension commencement lump sum to 25 per cent of the fund.
You also need to be very careful if you have any other benefits which you may consider transferring where the cash is also more than 25 per cent, as it is difficult to consolidate a number of occupational funds where each scheme has more than a 25 per cent cash entitlement.
Current rules state that there can only be one protected pre-A-Day cash sum within a registered scheme. In addition, a subsequent transfer to a scheme which already holds protected cash will reduce the cash from the second transfer to 25 per cent.
Please tread carefully.
Lisanne Mealing is a director at MDM Associates