It has been more than 13 years since the current pensions regime was ushered in on April 6 2006, a date known henceforth as “A-Day”.
Thirteen years might seem like a long time in everyday terms, but in pensions terms it’s no time at all – a pension being a vehicle that is with you several decades through your whole working life and into retirement.
Therefore, for some members, the pre-2006 rules are still very much relevant. In particular, there are still tens of thousands of members out there who are entitled to protected tax-free cash lump sums from before 2006.
These cases might not crop up very often, but the calculations are complicated, so it is worth revisiting them, particularly in light of post-2006 developments.
There are also a few quirks and exceptions that might not be obvious but could be costly if overlooked.
Protected tax-free lump sums
From A-Day, the maximum pension commencement lump sum (PCLS) available from a defined contribution (DC) scheme is usually calculated as 25 per cent of the funds being used to provide benefits.
This is subject to an upper ceiling of 25 per cent of the member’s available lifetime allowance.
Before A-Day, however, some occupational pension schemes and deferred annuity contracts permitted tax-free lump sums that amounted to more than 25 per cent of the fund.
In order that members were not prejudiced by the new A-Day rules, the government allowed them to keep their entitlement to the higher lump sums after A-Day.
In order for a member to still benefit from their lump sum protection, a series of conditions must be satisfied. If any of these points is not satisfied, the PCLS calculation reverts to the standard basis.
Firstly, in order to be eligible to a lump sum of more than 25 per cent, the following three points must apply:
- The individual was a member of a pension at April 5 2006.
- Their lump sum rights in that pension were more than 25 per cent of the uncrystallised funds.
- The individual did not apply for a protected lump sum as part of enhanced protection or primary protection.
Secondly, when it comes to actually receiving the lump sum, the following two conditions also apply:
- The member must become entitled to all their pension and lump sum rights on the same day. In other words, they have to take benefits from their whole fund.
- The benefits are paid from the scheme they originated in or from a scheme they were transferred to as part of a ‘block transfer’.
Within the second of these points, there are again several requirements relating to block transfers, which are worth covering in detail.
Block transfer requirements
Firstly, there must be two or more members transferring from the same transferring scheme to the same receiving scheme.
It is not essential that all transferring members have a protected lump sum, which is useful to note, and it is not unheard of for members to encourage friends or spouses to join the transferring scheme with a nominal contribution in order that they have a buddy to transfer with.
Secondly, each member must transfer all of their pension rights – in other words, a full transfer rather than a partial transfer – and the transfers must take place at the same time.
HM Revenue & Customs appreciates there may often be administrative and legal constraints, particularly with transfers in-specie, that mean all funds do not need to arrive on the same day.
Thirdly, the member transferring with a protected lump sum cannot have been a member of the receiving scheme for more than 12 months prior to the transfer. In our experience, this is the requirement that is most often overlooked.