This change could create a significant benefit for clients with protected tax-free cash rights in pension schemes set up before A-Day.
The PBR suggested that HMRC was looking to relax the rules for clients who could potentially benefit from an enhanced calculation of pre-A-Day protected tax-free cash, although the full detail was lacking. Since then, in discussions with Skandia and in recent announcements, we have been given a clearer message of what this will mean in practice.
The proposals mean that some clients could increase their protected tax-free cash beyond that currently available when they retire. Under today’s rules, when the client takes full retirement benefits from the scheme, the maximum tax-free cash will be the greater of their A-Day protected tax-free cash increased at the same rate as the lifetime allowance or 25 per cent of the final fund value.
Even if their investment performance is better than the increase in the lifetime allowance, for many clients it will mean their protected tax-free cash will not increase at the same rate.
This restrictive basis of provision could be overcome, provided the client has a relevant post-A-Day benefit accrual within the same scheme. For money-purchase schemes, this has simply meant making a contribution on or after April 6, 2006 to the same scheme holdingthe protected tax-free cash.
For many clients, the ability to pay an additional contribution to the same scheme after A-Day has not been available. The use of the block transfer legislation has allowed some individuals in this situation to transfer to a new registered scheme where they could make the additional contribution.
Clients with pre-A-Day section 32 contracts or with deferred pre-A-Day rights in occupational schemes where it may not be possible to use the block transfer rules were disadvantaged by comparison.
The new proposals will now provide a level playing field. The point is best illustrated with an example. Consider a client with a pension fund worth £100,000 on A-Day with protected tax-free cash of £50,000. The client decides to take benefits in 2010/11, by when the fund has grown by 40 per cent. Over the same period, the lifetime allowance has increased by only 20 per cent. Under current rules, the fund would have grown to £140,000 but the maximum lump sum payable would be £60,000. The tax-free cash percentage of 50 per cent of the fund on A-Day reduces to 43 per cent in 2010/11.
Under the new proposals, or where post-A-Day accrual has already taken place, the client will be able to take a slightly healthier £65,000 as tax-free cash, equivalent to 46 per cent. The difference arises because the client will also be entitled to an extra lump sum of £5,000. This is calculated as 25 per cent of the difference between the fund value when benefits are taken (£140,000) and the A-Day fund value increased in the same proportion as the increase in the lifetime allowance (£120,000), in other words, 25 per cent of £20,000, which is £5,000.
For any clients with a pension that has performed strongly since A-Day, the proposals will deliver a new opportunity to boost tax-free cash without having to make an extra contribution.
The next stage will be draft legislation which will be included in the 2008 Finance Bill, expected to be published in April and enacted in July. Advisers with clients who are thinking of releasing protected pre-A-day cash will need to consider whether a delay could be worthwhile.
Where clients have protected pre-A-Day tax-free cash in occupational or pre-A-Day section 32 pensions that are underperforming, it may be worth evaluating the benefits of transferring these funds to schemes that offer greater investment choice, with the potential that better performance may deliver more tax-free cash at retirement.
Colin Jelley is head of tax and financial planning at Skandia