What is the best way for a high-net-worth client to release tax-free cash following the A-day changes if they have a number of different sources of pension income?
The case that I dealt with for Paul was one of those that look quite straightforward on the surface but become far more complex as soon as you start to dig more deeply.
Paul was approaching his 60th birthday and wanted to look at how his pensions would work in conjunction with each other. I did some work for him before A-Day, especially as he would need to apply for protection, which would mean ceasing contributions to his pension schemes including a final-salary scheme.
Paul’s situation was that he had money in an AVC worth some 1m, a final-salary scheme which could provide 100,000 a year and an old section 32 policy worth some 250,000. It is not difficult to see from this that he needed to apply for enhanced protection as he was clearly over the lifetime allowance. This was all concluded satisfactorily before the end of last tax year but Paul then decided that he wanted to start taking benefits from his pensions later this year.
Deciding from which pension he was to take his tax-free lump sum was the critical question. The rules governing Paul’s finalsalary pension meant he was limited in terms of his tax-free cash allowance to 25 per cent of the lifetime limit. Thus, he had to find 375,000 from his other pension schemes.
It is worth pointing out that at this stage Paul had certified tax-free cash of some 180,000 within his section 32 contract. This is a quite significant proportion of the 250,000 and would seem to indicate that we should advise him to take as much tax-free cash as he could from this particular contract. However, on delving deeper it became apparent that Paul also had a guaranteed annuity on part of this pension.
Basically, this was in two parts, with 50,000 being protected rights and 200,000 being non-protected rights. The non-protected rights had a guaranteed annuity rate of 10 per cent so it was not a good idea to take any tax-free cash from this particular part as to try and replace a 10 per cent guaranteed return was a bit of a tall order.
The ideal solution would have been to take the tax-free cash entirely from his AVC as the commutation factors of taking the tax-free cash element from the finalsalary scheme were not in his favour. This is also an excellent scheme in terms of security and pension increases and we did not want him to lose out on these.
Of course, the decision on where to take the tax-free cash depended on how the final-salary scheme trustees viewed the matter. The commutation factors favour the scheme and not the client (Paul would have to give up a lot of pension for the cash) and the trustees were reluctant to allow any tax-free cash to be paid from the AVC and wanted it all to be taken from the final-salary scheme. In the end, a compromise was reached whereby the client was able to take 50 per cent of the tax-free cash from the AVC – a good outcome for him – and the other 50 per cent from the final-salary scheme.
This left his guaranteed annuity income from the section 32 contract, with 50,000 protected rights to be dealt with later.
The remaining AVC sums were put into a self-invested personal pension to be managed for him and to permit an income to be drawn at some stage in the future, as he did not need it at the moment.
His wife did not lose out on the final-salary scheme either, as the widow’s benefit was not affect by any tax-free cash sum coming out of the final-salary scheme.
So what started off looking fairly straightforward turned into a much more complex case because of the various ways that the income and cash could be drawn. It was a favourable outcome that an excellent, secure income could be paid both from the section 32 and final-salary scheme pensions.
Amanda Davidson is a director at Baigrie Davies