While the impact of A-Day protection on total pension size tends to be reasonably well understood, the effect of protection on tax-free cash is not as straightforward, and individuals who hold primary or enhanced protection who are expecting to take 25 per cent of their pension benefits as tax-free cash may well be disappointed, says Victoria Harman in this month’s Tax Spotlight.
Individuals were able to incorporate lump sum protection within their application for primary protection or enhanced protection where total lump sum rights on 5 April 2006 exceeded £375,000.
For uncrystallised funds this was the value of the lump sum rights as if the member had reached normal retirement age by that date. For crystallised funds, lump sum rights were deemed to be 25 per cent of the notional capital value, which was 25 times the annual income by the date, whereas in drawdown the annual income was deemed to be maximum Gad.
The monetary lump sum entitlement on 5 April 2006 is increased in line with the lifetime allowance (LTA) under primary lump sum protection, but underpinned at £1.8m. Under enhanced lump sum protection the percentage lump sum entitlement at 5 April 2006 is used as the personal percentage entitlement in place of the standard 25 per cent.
Instances of individuals applying for primary or enhanced protection being deemed ineligible for protected tax-free cash because their total lump sum rights at 5 April 2006 were valued below £375,000 were not uncommon.
Ms Harman said, “Without primary or enhanced lump sum protection the individual is limited to the lower of 25 per cent of the fund and 25 per cent of the standard LTA. From 6 April 2014 the ‘standard’ LTA for this purpose has been underpinned at £1.5m. Previous benefit crystallisation events (BCEs) need to revalued in line with the £1.5m underpinner LTA to assess how much remains available to provide tax-free cash.”
The reduction in standard LTA brings some anomalies in the calculation of tax free cash where an individual holds primary or enhanced protection without lump sum protection. Two separate calculations need to be undertaken – one to assess the personal LTA and one to assess the available lump sum.
“The legislation introducing the £1.5m underpin applies it to all previous BCEs. Applying it to BCEs post-April 2014 will artificially increase the value of that BCE, because the standard LTA has now dropped to £1.25m. This means that phasing benefits post-April 2014 could further reduce the availability of tax-free cash,” Ms Harman said.
In occupational schemes where the lump sum entitlement on 5 April 2006 was above 25 per cent, scheme-specific protection applies. Primary and enhanced protection take precedence but in their absence, scheme-specific lump sum protection may apply.
