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Pension edge: Mike Brown

Careful selection of the right section 32 policy will provide the solution for many clients who are members of occupational pension schemes and are looking to protect their accrued tax-free cash entitlement after A-Day.

Pension simplification is like the curate’s egg – good in parts. One of the most significant changes affects tax-free cash, which will be at a common rate of 25 per cent of the fund after A-day. While this is good news for scheme members who are currently entitled to less than 25 per cent, it could be bad news for many members of company pension schemes unless they take steps to protect their accrued tax-free cash entitlement.

IFAs keen to maximise the opportunities presented by the new regime face a massive task to advise clients on the most appropriate way to protect their tax-free cash before A-day. As ever, there is no one-size-fits-all solution. Selecting the right solution will:Take into account clients’ existing circumstances.Ensure that clients’ existing tax-free cash rights are protected.Anticipate clients’ future needs as far as possible.

The last point is especially important for some clients currently entitled to tax-free cash above 25 per cent of the fund. For these clients, an individual transfer to another arrangement after A-Day – as opposed to taking part in a bulk transfer – will mean that their tax-free cash is restricted to the new 25 per cent limit.

Preserving the higher amount can be as easy as staying in the existing arrangement and, for some clients, this will be the most appropriate course of action. However, to ensure the existing arrangement is likely to meet the client’s future needs as far as possible, the following should be considered.Investment freedom through a self-investment facility. Although a client may not currently consider that self-investment is important, over time the freedom of self-investment may become a key issue.Post A-Day contributions. A contribution of just 1 paid after A-Day can, depending on investment growth, release a significant additional amount of tax-free cash.Flexibility over taking benefits – particularly phased income withdrawal, which permits the ultimate in flexibility.

Paragraph 31(3) of Schedule 36 of the Finance Act confirms that, under certain circumstances, an entitlement to tax-free cash over 25 per cent is lost unless “the individual becomes entitled to all the pensions payable to the individual under arrangements under the pension scheme … on the same date”. Therefore, any single scheme, such as an executive pension plan or small self-administered scheme or a multi-segment scheme such as a personal pension or self-invested personal pension, cannot be used to achieve phasing of benefits while preserving the client’s tax-free cash entitlement. Only a multi-scheme or clustered structure will achieve this.

It should be noted that Paragraph 31(3) of Schedule 36 of the Finance Act does not apply where an individual has registered for enhanced and/or primary protection and his/her tax-free cash entitlement at A-Day exceeds 375,000.

A clustered structure is a cluster of totally separate but identical policies. From April 6, 2006, by virtue of paragraph 1(1)(d) of Schedule 36 of the Finance Act, a section 32 policy will be treated as a registered pension scheme. Therefore, a cluster of section 32 policies is effectively a cluster of registered pension schemes.

A segmented structure is one single scheme, for example, a Sipp, divided up into a number of identical smaller arrangements, all of which form part of the whole scheme.

The key difference is that under a segmented scheme, taking benefits under some but not all of the arrangements would constitute taking less than the full entitlement from the scheme and, as a result, tax-free cash would be restricted to a maximum of 25 per cent for each arrangement.

A section 32 policy can meet the above criteria:Self-investment. Section 32 policies can offer self-investment through a private managed fund. Investment in residential property from A-Day is very much a hot topic.

While insurance company regulations currently do not permit direct investment in residential property, a private managed fund can offer geared exposure to residential property through collectives or structured products, both today and after A-Day.Ongoing contributions. The Inland Revenue has confirmed to us verbally that section 32 policies will be able to receive contributions after A-Day. Given favourable investment growth after A-Day, this will enable section 32 policyholders to further increase their tax-free cash after A-Day.

However, poor investment returns following A-Day could have the opposite effect and the ideal strategy would be to leave the decision whether to contribute to the section 32 policy until just before vesting.Flexibility over taking benefits. Section 32 policies can be clustered to ensure that, after A-Day, tax-free cash in excess of 25 per cent is preserved while the client retains the ability to phase benefits.

Clearly, IFAs need to take great care when giving advice in the run up to A-Day. Careful selection of the right section 32 policy will provide the solution for many clients who are members of occupational pension schemes or who already have a section 32 policy that may not meet their future needs.

Mike Brown is head of pensions and retirement at Abbey for Intermediaries

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