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Stewart Ritchie on pensions

There is one particular area of transition to the new pension regime which may be complex for large numbers of ordinary people – the protection of tax-free cash.

Something like half of all members of occupational pension schemes and section 32 policies will have an accrued entitlement to tax-free cash at April 6, 2006 greater than 25 per cent of the value of the total accrued benefits. The principle is these people can have protection of the higher amount as if they were early leavers at April 6, 2006, increased from then to crystallisation date (the date the tax-free cash is taken) by the same proportion as the lifetime allowance rises. In addition, the member can have as tax-free cash 25 per cent of the value of benefits, including investment growth, accruing after April 6, 2006.

The Inland Revenue does not want to pre-register this tax-free cash transitional protection unless the person is also registering for primary or enhanced protection. It is important that somebody is holding a snapshot of the April 6, 2006 data in such a form that the correct calculation is done at retirement and the higher figure can be justified to the Revenue. This may, for example, involve the holding of 13 years of maximum pensionable earnings between 1993 and 2006 so that “best three consecutive starting in the last 13” can be used to optimise the definition of tax-free cash.

An adviser can perform a valuable service by checking whether a client would have a transitional entitlement greater than 25 per cent. If yes, then who is going to hold a snapshot of the data? The IFA could assemble it and hold it on the client’s behalf.

If someone is choosing primary or enhanced protection and has a transitional tax-free cash entitlement greater than 375,000, then the specific amount must be recorded with the Revenue as part of the registration process for benefit protection.

A few words of caution. Depending on whether or not a “scheme pension” is chosen as the crystallisation option after A-Day, it is possible to come up with some strange definitions of tax-free cash. These could be substantially above or below 25 per cent of fund value, depending on the exact type of annuity rate chosen. It seems the Revenue may have got itself into a more complex situation than it intended.

One particular sting in the tail with transitional tax-free protection arises if a person decides to transfer out of the occupational pension scheme or s32 policy after April 6, 2006. Unless they have opted for primary or enhanced protection on transfer, they will lose the transitional tax-free cash protection. They could perhaps manufacture a “bulk transfer” situation after April 6, 2006 to maintain the protection but that needs the cooperation of the employer and at least one like-minded other scheme member.

This creates an urgent advice issue. If people have a preserved entitlement in a money-purchase occupational pension scheme including tax-free cash greater than 25 per cent and are likely to want to transfer it, they should strongly consider doing so before April 6, 2006. The only receiving vehicles which maintain transitional tax-free cash protection are another occupational pension scheme or an s32 transfer policy. The person will be lucky if they find their new employer has an occupational pension scheme open to transfers. A transfer to a personal pension or stakeholder defeats the object because that would reduce-tax free cash to 25 per cent. So that leaves an s32, and preferably one which allows 1 to be paid in after April 6, 2006 if that turns out to give a superior tax-free cash definition.

Stewart Ritchie is director (pensions development) at Scottish Equitable

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