This CPD article covers the concept of scheme-specific lump sum protection, the conditions for payment and how the calculations interact with lifetime allowance protections.
You will also learn how clients might be able to transfer their existing pensions without losing their protection and a piece of legislation that can help clients access pensions flexibly even in older-style contracts.
Scheme-specific protection is a form of transitional protection – in other words, protecting pension rights that accrued before a major rule change.
In this case we are concerned with tax-free lump sum rights that arose in a particular scheme before 6 April 2006 (A-Day) that are specific to that scheme.
Retirement ages could also be protected in specific schemes. Other forms of transitional protection, by comparison, apply across all the members' registered pension schemes. Lump sum entitlements protected under enhanced or primary lifetime allowance are treated differently and are out of scope of this article.
Members did not need to apply to HMRC of this protection. It was all documented by the scheme administrators of the schemes concerned.
What lump sums are protected under these rules?
Following pensions simplification, the maximum pension commencement lump sum (PCLS) a member can take is the lower of 25 per cent of the value being crystallised and 25 per cent of the member’s available lifetime allowance.
For most members of registered pension schemes, the lump sum rules applying now are at least as favourable as the rules that applied before 6 April 2006.
However, there are some members whose lump sum rights at A-Day exceeded 25 per cent of their fund value due to the previous calculation methods.
For these members, a degree of protection is given for their lump sum rights as they stood at 5 April 2006.
These lump sum rights will have accrued under occupational schemes or deferred annuity contracts. Tax-free cash of more than 25 per cent was not available in personal pension schemes.
As the rights were held in specific schemes, it was decided that scheme administrators could document the protected amounts themselves based on their A-Day records. There are no certificates for this form of protection.
There are three conditions that must be met for scheme-specific protection to apply:
- the benefits must be paid from the scheme in which the rights were held on 5 April 2006 (the original scheme) or a registered pension scheme to which the rights were transferred as part of a block transfer after 5 April 2006;
- the uncrystallised lump sum rights in the original scheme on 5 April 2006 were more than 25 per cent of the value of the uncrystallised pension rights in the scheme on that date; and
- the member must become entitled to all their pension and lump sum rights (that were not in payment on 5 April 2006) under the scheme on the same day.
Protected PCLS in practice
The maximum PCLS a client with scheme specific protection is entitled to is -
- the monetary amount the member was entitled to at A-Day, revalued in line with changes in the lifetime allowance since that date (‘LS’)
- an additional lump sum amount (‘ALSA’) which is broadly equivalent to 25 per cent of the fund growth, contributions and transfers-in since A-Day.
- LS = £ tax free cash at A-day x 120 per cent*
- ALSA =[£ total fund value - (A-day fund value x standard LTA / £1.5m)] x 25 per cent
Having calculated the protected lump sum, you calculate the additional lump sum amount. The two are then added together.
*This uplift will be 120 per cent until such time the standard lifetime allowance rises above £1,800,000.