Transitional tax-free amount certificates – an explanation

Most individuals shouldn’t need to apply for a certificate. The standard calculation will accurately reflect the tax-free lump sums taken prior to 6 April 2024. HMRC has published guidance making it make clear that the certificates should only be requested by individuals who have used less of their available lifetime allowance as tax-free lump sums than under the standard calculation — for instance they did not take their tax-free cash lump sum. 

Why are transitional tax-free amount certificates being introduced?

The lifetime allowance is being abolished on 5 April 2024 and replaced with new allowances, the lump sum allowance and lump sum and death benefit allowance.

Before 6 April 2024, it was the total value of benefits being taken that were tested against the lifetime allowance.

From 6 April 2024, it is the amount of tax-free benefits that are tested against the lump sum allowance and lump sum and death benefit allowance.

As part of the abolition of the lifetime allowance, benefits crystallised before 6 April 2024 must be converted into remaining lump sum allowance and lump sum and death benefit allowance.

How is the lifetime allowance used converted into remaining lump sum allowance and lump sum and death benefit allowance? 

There is a standard calculation to convert the percentage of the lifetime allowance used into a monetary amount. In most cases 25% of this amount is viewed to be what was paid tax-free. If the individual doesn’t have any lifetime allowance protection this will be:

(Lifetime allowance percentage used x £1,073,100) x 25% = tax-free benefits paid

If the individual has a form of lifetime allowance protection, the £1,073,100 is replaced with the lifetime allowance that applies to the individual, for example £1.5 million for fixed protection 2014.

The amount of tax-free benefits paid before 6 April 2024, as calculated by the standard calculation above, is then deducted from the standard lump sum allowance and lump sum and death benefit allowance. This gives you the individual’s remaining lump sum allowance and lump sum and death benefit allowance for future relevant benefit crystallisation events.

The calculations are slightly different if a serious ill-health lump sum has been paid. See our article What replaced the lifetime allowance on 6 April 2024?

Who can apply for a certificate?

An individual or the legal personal representatives of a deceased individual.

They can only apply to a scheme the individual is a member of or was immediately before their death.

HMRC expects the request to go to the scheme who will pay the first benefits after 6 April 2024.

How do I decide whether to apply for a transitional tax-free amount certificate?

Who would benefit from applying for a transitional tax-fee amount certificate, seems like a simple question but it isn’t as clear cut as it seems!

There are a few important points below to think about before we cover the factors that you should take into account when making a decision.

Where to start if you are deciding whether to apply?

The first thing to consider is whether the total amount of tax-free benefits (that is tax-free cash and the tax-free element of any UFPLS taken) they received from their pension savings before 6 April 2024 is less than 25% x percentage of the lifetime allowance used up on 5 April 2024 x £1,073,100.

Where an individual has lifetime allowance protection, the £1,073,100 is replaced by their protected lifetime allowance amount. It is the result of that calculation which is the basis of the decision whether to apply for a certificate.

Is the amount of the individual's pension savings such that the lump sum allowance and lump sum and death benefit allowance is likely to be an issue?

A certificate could give more lump sum allowance and lump sum and death benefit allowance but if the individual is never going to be close to using these allowances there is little or no point in applying. However, the individual needs to look at the current level of savings they hold and the potential level of funds that could be built up. They must check whether the remaining funds, if paid as a lump sum on death, would be more than the remaining lump sum and death benefit allowance.

It's worth noting that if an individual receives death benefits in the form of beneficiary drawdown, they are not tested against the new allowances. However, if they are then subsequently paid out on that individual’s death as a lump sum, it will be tested against their lump sum and death benefit allowance. If there is insufficient lump sum and death benefit allowance remaining, the benefits could be designated to drawdown to a named beneficiary or dependant. They could then take the entire amount as an “income” payment which would not be tested against the lump sum and death benefit allowance. It is essential to keep nominations up to date to allow this. It is important to note that death benefits from benefits crystallised before 6 April 2024 will never be tested against the lump sum and death benefit allowance.

In this table we cover the reasons why less tax-free benefit could have been paid before 6 April 2024 that may make applying for a transitional tax-free amount certificate worthwhile. Remember looking at these points in isolation may be misleading, the individual has to look at all of them and then look at the overall position.

Should you apply for a transitional tax-free amount certificate if you had used 100% of the lifetime allowance?

At first glance there doesn’t seem to be any point, as it will not generate any more lump sum allowance, if 25% or more tax free cash was taken. However, there is an impact on the available lump sum and death benefit allowance.

It is important to note that if 100% of the lifetime allowance has been used, the lump sum and death benefit allowance available after 5 April 2024 is reduced to zero.

Applying for a transitional tax-free amount certificate could potentially give back 75% of the lump sum and death benefit allowance.

An example might help to bring this to life.

On 14 July 2023, an individual with no lifetime allowance protection, has funds worth £2,000,000. They have already crystallised benefits up to the lifetime allowance at that time, £1,073,100 and took 25% tax-free cash. They had no other benefit crystallisation events. This resulted in £268,275 tax-free cash being paid with the balance designated to drawdown. They also have uncrystallised funds of £926,900.

After 5 April 2024, as the individual doesn’t have any lifetime allowance left and they don't have a transitional tax-free amount certificate, they won't have any lump sum allowance or any lump sum and death benefit allowance. This means, on their death before age 75, the benefits (ignoring any pre-6 April 2024 crystallised benefits) will be liable to income tax at the recipient’s marginal rate if taken as a lump sum.

If the individual had a transitional tax-free amount certificate it would show £268,275 lump sum allowance used and zero remaining. It would also show £268,275 lump sum and death benefit allowance used and £804,825 remaining.

With the certificate, on the individual’s death before age 75 and after 6 April 2024 the uncrystallised fund of £926,900 can be paid as a lump sum, with £804,825 paid tax-free and £122,075 taxable at the recipient’s marginal rate of income tax. Remember, the pre-6 April 2024 drawdown fund is not tested against the lump sum and death benefit allowance.

Regardless of whether the individual had applied for a certificate and died under age 75, the remaining uncrystallised fund can be designated as beneficiary drawdown on their death if this option is available. Then the entire drawdown fund can be paid out as one “income” payment tax-free as it wouldn’t be tested against the lump sum and death benefit allowance. Though this would require the beneficiaries to be nominated by the individual, if they are not dependants, in order for them to be able to select drawdown as an option.

Pre-commencement pensions

Pre-commencement pensions is the name given to benefits taken before 6 April 2006. Individuals whose only pensions in payment is a pre-commencement pension, and who have had not had any benefit crystallisation events between 6 April 2006 and 6 April 2024, are not within scope for applying for a transitional tax-free amount certificate.

Individuals who have a pre-commencement pension in payment, but they have had one or more benefit crystallisation events between 6 April 2006 and 6 April 2024, will be eligible to apply for a transitional tax-free amount certificate.

However, although a certificate usually reflects the tax-free benefits taken pre-6 April 2024 accurately, this isn’t the case for pre commencement pension benefits. An assumption of 25% of the deemed crystallisation event amount at the first benefit crystallisation event is assumed rather than the tax free cash amount actually taken pre 6 April 2006.

What will the transitional tax-free amount certificate do?

The transitional tax-free amount certificate will accurately reflect the tax-free lump sum benefits taken before 6 April 2024. Benefits are not revalued; it only takes into account what has been paid.

The certificate shows the amount the scheme administrator is satisfied is the individual’s remaining lump sum transitional tax-free amount and individual’s lump sum and death benefit transitional tax-free amount. It will also show the percentage of lifetime allowance used.

It is important to note, that when someone is over 75, their remaining lump sum and death benefit allowance is effectively zero. This is because all death benefits paid on death after age 75 are taxable.

When should somebody apply?

An individual must apply for a certificate before the first relevant benefit crystallisation event after 5 April 2024. It is not possible to apply after the first relevant benefit crystallisation event. An individual can only apply successfully once. 

Scheme administrators have three months from when they receive the required evidence to produce the certificate.

It is extremely important to note, if an individual applies and the certificate shows a lower remaining lump sum allowance and lump sum and death benefit allowance than the standard calculation it cannot be disregarded or cancelled. Individuals shouldn’t apply for a transitional tax-free amount certificate where this may happen. Legislation does not allow for individuals to apply so they can compare the results under each process. There is no opportunity to revert to the standard calculation once a transitional tax-free certificate has been granted.

Unlike before 6 April 2024, where if you retrospectively applied for fixed or individual protection your lifetime allowance percentage used could be recalculated, it is not possible to revisit relevant benefit crystallisation event.

Another important point, if there is a planned relevant benefit crystallisation event shortly after 6 April 2024, the individual may want to delay it if they intend to apply for a transitional tax-free amount certificate. It is extremely important to note that a drip feed drawdown instalment is a relevant benefit crystallisation event.

How do you apply?

This is entirely new, there isn’t a standard process for applying to a scheme administrator. The onus is on individual to provide the evidence of their actual tax-free amounts used prior to 6 April 2024. This evidence constitutes part of the application.

Legislation requires ’complete evidence‘ to be supplied to the scheme administrator asked to produce the certificate, but this term has not been defined. Complete evidence must always account for the total amount of lifetime allowance used so the scheme administrator can determine what portion of those pension benefits were taken as tax-free lump sums. However, evidence will need to be considered on a case-by-case basis.

It is likely a scheme administrator will require documentary evidence showing the lifetime allowance used and the tax-free cash paid as part of the benefit crystallisation. Evidence may include records such as a statement from a scheme showing the amount of lifetime allowance used at a benefit crystallisation event, settlement letters, financial records or bank statements. The total of all the lifetime allowance percentages used, in the evidence, must equal the total percentage the individual lifetime allowance used. If this cannot be provided the scheme is likely to refuse to produce a certificate due to incomplete evidence.

Before applying, an individual should check their records to make sure applying for a certificate is the best course of action. If not, it is possible the transitional tax-free amount certificate may give the individual a smaller available lump sum allowance and lump sum and death benefit allowance than the standard calculation. 

It may be time consuming for an individual to pull together this complete evidence. The scheme administrator then has three months to produce the certificate. If the individual would like to rely on a certificate before their first relevant benefit crystallisation event, pre-planning will be required. This is particularly important if there are any automatic relevant benefit crystallisation events happening shortly after 6 April 2024.

Future HMRC guidance will provide examples of what might be considered due diligence and accepted as complete evidence.

Are there any penalties if an inaccurate certificate is issued?

Where a certificate is found to inaccurately reflect an individual’s lump sum or lump sum and death benefit transitional tax-free amount, the certificate should be cancelled by the scheme administrator. An individual may then be liable for any additional tax due if their available allowances are less than the amount shown on their certificate.

Where a scheme administrator receives inaccurate information from an individual, it will not be penalised for producing an incorrect certificate, unless it is found that they acted fraudulently or negligently.

There will be a penalty of £3,000 where an individual fraudulently or negligently makes a false statement, or a pension scheme administrator assists in providing a statement they know to be inaccurate.