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Tax-free transfers

Pension transfers have been very much in the news recently with the FSA releasing its report on the quality of advice on pension switching and the impact of market volatility on fund values.

The FSA’s report mentioned “loss of benefits for clients” on transfer. In this context, they specifically made reference to the value of guaranteed annuity rates but another valuable benefit that requires consideration is tax-free cash.

It is three years since A-Day and the ability to keep what you had at A-Day, tax-free cash-wise, has continued to be of great importance. It is certainly an area that we still receive enquiries about and one that advisers need to consider carefully when looking at pension transfers.

What you need to consider

With A-Day came the universal cap for tax-free cash of 25 per cent of the value of benefits or fund value. This was OK for personal pension or stakeholder plans, where the 25 per cent rule had always applied. But many clients in occupational-type pension schemes, including EPPs, Cimps, section 32s, etc, had an entitlement before A-Day to more than 25 per cent of the value of their benefits.

The A-Day protection rules were designed to allow clients to keep this entitlement after A-Day. For most, this meant they benefited from scheme- specific protection, with the protection applying to the scheme the client was in at A-Day. If it is to apply in another scheme, then there are rules that need following.

What you need to consider is how important tax-free cash is to your client. If it is important, you need to ensure on any transfer out of the pre-A-Day scheme to another scheme that your client does not lose their protected cash.

In many cases, entitlement to tax-free cash can be a high percentage of pre-A-Day benefits. Clients who had tax-free cash of more than £375,000 (one quarter of the lifetime allowance at A-Day) can apply to HMRC for primary or enhanced protection of their pre-A-Day tax-free cash. Clients who have this protection can transfer as many times as they like and still retain their pre-A-Day tax-free cash entitlement.

Maintaining protected tax-free cash on transfer

How do you make sure protected tax-free cash is maintained on transfer? First, you need to know your clients. Who has protected cash? Clients who do should be flagged to ensure this is always taken into account.

Second, you need to know the rules and follow them. The majority of clients who have more than 25 per cent of the value of their benefits as tax-free cash will have scheme-specific protected tax-free cash.

This can only be maintained where the transfer from the A-Day scheme is part of what is known as a block transfer or a wind-up transfer.

Block transfer

A block transfer is a transfer where two or more members of the same scheme transfer to the same receiving scheme.

It is worth noting here that providers operate personal pension schemes and that these will qualify as being the same scheme for the purposes of the block transfer rules.

This means that you can transfer two members of an occupational pension scheme who have more than 25 per cent worth of pre-A-Day tax-free cash to the same personal pension scheme and maintain this level of cash allowance.

Similarly, you can transfer the same clients to a GPP, a stakeholder pension (or group stakeholder) or another occupational pension scheme and maintain the protected cash.

To meet the block transfer rules, clients must transfer all of their benefits under their scheme, including any in-house AVCs, protected rights, etc, at the same time.

In addition, clients cannot have been a member of the receiving scheme for more than 12 months unless the receiving scheme is a personal pension or stakeholder plan set up for contracting-out only.

A transfer to a section 32 plan cannot be a block transfer as section 32s cannot have more than one scheme member.

It is important to be particularly careful with clients who have more than one pension plan with pre-A-Day protected cash. If you transfer both of these plans to the same scheme, the client will only be entitled to the protected cash amount from one of the transferred plans, not both. This could significantly reduce their tax-free cash entitlement.

Wind-up transfer

This is a specific type of transfer that allows scheme-specific protected tax-free cash to be maintained on transfer to a deferred annuity contract (section 32). It can be used for a single member. There are a number of conditions.

The winding-up condition – as the name suggests, the transferring scheme has to be winding-up. It also has to have been in force before A-Day. It does not matter whether the scheme started winding-up before or after A-Day.

The annuity purchase condition – basically, this requires the receiving scheme to be a deferred annuity contract (section 32).

By using this approach, an occupational pension scheme can wind up and, as long as it was in force before A-Day, can issue individual policies to members, allowing them to maintain any protected tax-free cash.

Assignment

It is worth noting that the assignment of benefits under any scheme to an individual member never maintains protected tax-free cash. The protection will always be lost.

By understanding, and following, these rules you can ensure that your clients do not lose their cash.

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