PensionsApr 24 2023

How protected tax-free cash will work in new pensions regime

  • Describe the rules around tax-free cash
  • Explain how the rules have changed following the Budget
  • Explain how protection, brought in over the past 20 years has affected pension savers
  • Describe the rules around tax-free cash
  • Explain how the rules have changed following the Budget
  • Explain how protection, brought in over the past 20 years has affected pension savers
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How protected tax-free cash will work in new pensions regime
The amount of tax-free cash an individual can take over their lifetime is being kept frozen at the current level of £268,275 (Photo: Financial Times)

If the member had a tax-free cash entitlement of more than £375,000 on April 5 2006, then their protection certificate included the percentage of their fund they could take as tax-free cash. This percentage could be more or less than 25 per cent. 

HMRC has now confirmed that the maximum amount of tax-free cash these members will be able to take will be the lower of:

  • the protected percentage of their fund when they take benefits; and 
  • their entitlement on April 5 2023. 

This makes sense. Otherwise, as it is calculated as a percentage of the final fund, once the member restarts contributions their tax-free cash entitlement would go shooting up in value — and that would go against the spirit of the new regime. 

Below is an example of how it works:

If on applying for enhanced protection, the member’s tax-free cash entitlement was less than £375,000, then there would not be a specific pension commencement lump sum percentage on the protection certificate. 

For these members, their tax-free cash is calculated as the lower of:

  • 25 per cent of their current fund; or 
  • 25 per cent of £1.5mn. 

This rule carries on into the new tax year. 

Fixed protection

As the LTA tumbled in value during the 2010s, there were three different opportunities for members to protect their higher LTA through fixed protection — in 2012, 2014 and 2016.

On these occasions an individual applying for fixed protection got to keep the higher LTA and higher tax-free cash entitlement, but generally only as long as they stopped contributing or stopped building up benefits in a DB scheme. 

 

Protected LTA

Maximum PCLS

Fixed protection 2012

£1.8mn

£450,000

Fixed protection 2014

£1.5mn

£375,000

Fixed protection 2016

£1.25mn

£312,500

From April 6 2023, fixed protection members can “break” these protection rules and restart contributions to their pension, while keeping their tax-free cash protection. This is as long as they had already applied for their fixed protection before March 15 2023.

Primary and individual protection

Pension scheme members may have also had the choice of opting for primary (2006 only) or individual protection (2014 and 2016).

To apply for these protections, their pension value had to be above a certain amount. They could apply to protect their pension value at this amount and carry on contributing to their pension or building up benefits in a DB scheme and keep their protection. Their tax-free cash would also be protected at 25 per cent of their protected LTA.

These members are not affected by the new pension tax rules. They can continue contributing and can continue to protect their PCLS at a higher amount, rather than being restricted to £268,275.

Late applications

Applications for primary and enhanced protection closed on April 5 2009. Applications for fixed protection 2012 closed April 5 2012, and for fixed and individual protection 2014 they closed on April 5 2014.

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