Transitional tax-free amount certificates – an explanation

Published  02 April 2024
   10 min read

Here we explain what a transitional tax-free amount certificate is and does.  How to decide whether to apply for one and what information would allow you to successfully apply for one.

Important note

This article is based on our understanding of the Finance Act 2024 and other supplementary documents, such as HMRC newsletters.

HMRC’s newsletter 158 has provided the following update on:

Transitional arrangements — PCLS and uncrystallised funds pension lump sum (UFPLS) after age 75

Currently, the payment of a PCLS or UFPLS after age 75 is not a benefit crystallisation event (BCE). This is because the individual’s remaining uncrystallised benefits would have been tested against the LTA at age 75. However, when applying for a TTFAC, paragraph 129(3) of Finance Act (FA) 2024 only considers lump sums which were paid as a BCE under Part 4 of FA 2004.

The government will therefore bring forward legislation to provide that the transitional tax-free amount considers any PCLS or (tax-free element of an) UFPLS paid after age 75. This will ensure that any TTFAC issued accurately reflects any tax-free lump sums received prior to 6 April 2024.

Schemes should ensure that this information is included in any TTFAC issued where relevant, as once the amending legislation comes into force and is applied retrospectively to 6 April 2024, any TTFAC issued which does not reflect these amounts will be incorrect.

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 will shortly publish 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.

In what circumstances should someone apply?

This isn’t as clear cut as it first appears. In general, the following is a good indication, however there are circumstances when the opposite could be true! 

As an example, if someone took sizeable benefits when the lifetime allowance was £1.8 million and smaller amounts when the lifetime allowance was less than £1,073,100. The tax-free cash paid when the lifetime allowance was £1.8 million will be higher than the standard calculation, and conversely the tax-free cash paid when it was less than £1,073,100 will be lower. In these circumstances it would be advisable to calculate the total tax-free cash paid and compare that amount with the standard calculation. If the total actually paid tax-free was higher, then it will not be beneficial to apply for a certificate.

Where applying for a certificate is not likely to be beneficial

Those who before 6 April 2024:

  • Have not crystallised any benefits.
  • Only took tax-free cash lump sums when the lifetime allowance was £1,073,100 or more and they only ever took the full 25%.
  • Have only taken scheme specific tax-free cash but had no lifetime allowance protection.
  • Have only taken a stand-alone lump sum.

Where applying for a certificate is likely to be beneficial

Those who before 6 April 2024:

  • Took less than 25% tax-free cash.
  • Only crystallised benefits when the lifetime allowance was below £1,073,100.
  • Took benefits that contained a disqualifying pension credit.
  • Took benefits that contained GMP and that restricted the tax-free cash paid out to less than 25%.
  • Had an age 75 test.
  • Transferred benefits overseas (BCE 8) but still have benefits in the UK that they will crystallise in the UK.

Should you apply for 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.

If the individual above had not 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. 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 who’s only pensions in payment is a pre-commencement pension, and they 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.

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?

HMRC do not expect people will apply before 6 April 2024.

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 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. 

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 pension scheme administrator assists in providing a statement they know to be inaccurate.

The LSA and LSDBA is reduced by benefits already taken pre-6 April 2024.   

Assuming she hasn’t taken any benefits after 5 April 2024 already:

  • Her remaining LSA = £268,275 – (25% x previously used % of lifetime allowance on 5 April 2024 x £1,073,100). 

= £268,275 – (25% x 90% x £1,073,100) 
= £268,275 - £241,447.50 
= £26,827.50 

  • Her remaining LSDBA = £1,073,100 – [(25% x previously used % of lifetime allowance on 5 April 2024 x £1,073,100) + (the amount of any serious ill health lump sum paid prior to 6 April 2024)]. 

= £1,073,100 - £241,447.50 – 0 
= £831,652.50 

As she still has uncrystallised funds of £1 million, she can take up to £26,827.50 as tax-free cash.  

Question 28 of HMRC’s Lifetime allowance guidance newsletter - March 2024 also shows another example. 

Question 29 of the same HMRC Newsletter gives an example of how it applies for someone with Protection.  

Generally, death benefits will be tax-free if the member dies before age 75 as long as they’re paid within two years of when the provider knew or should have known of the death.  

However, any tax-free lump sums are tested against Elinor’s remaining LSDBA. So, £831,652.50 will be tax-free and the remaining £168,347.50 will be taxed at the recipient’s marginal rate of income tax. 

If benefits are taken as beneficiary drawdown/annuity, they will not be tested against the LSDBA so will be tax-free if the member died under age 75. 

  • As he has crystallised benefits pre-6 April 2024, his LSA/LSDBA will be reduced by (25% x previously used % of lifetime allowance on 5 April 2024 x £1,073,100) 

= (25% x 45% x £1,073,100)  
= £120,723.75 

  • His LSDBA will also be reduced by the amount of any serious ill health lump sum paid prior to 6 April 2024. Our assumption for this example, is that he hasn’t had one paid. 

As the actual tax-free cash he took of £105k is less than the £120,723.75 he will have assumed to have taken, it makes sense for him to apply for a transitional tax-free amount certificate.  

  • As she has crystallised benefits pre-6 April 2024, her LSA of £375k and LSDBA of £1.5 million will be reduced by (25% x previously used % of lifetime allowance on 5 April 2024 x £1,500,000).

= 25% x 90% x £1,500,000 
= £337,500. 

  • Her LSDBA will also be reduced by the amount of any serious ill health lump sum paid prior to 6 April 2024. Our assumption for this example, is that she hasn’t had one paid.  

As the actual tax-free cash she took of £322k is less than the £337,500 she will have assumed to have taken, it makes sense for her to apply for a transitional tax-free amount certificate.

If he doesn’t apply for a transitional tax-free amount certificate, his LSA and LSDBA will be nil as he has used up all his lifetime allowance pre-6 April 2024.  

  • If he does apply for a transitional tax-free amount certificate,  his LSA of £375k and LSDBA of £1.5 million will be reduced by (25% x previously used % of lifetime allowance on 5 April 2024 x £1,500,000) 

= (25% x 100% x £1.5 million) 
= £375,000 

This means his LSA will still be nil (as £375,000 - £375,000) but his LSDBA will be £1,125,000 (£1,500,000 - £375,000).  

If Martin dies under age 75, and his uncrystallised fund is now worth £600k, his beneficiary/ies could choose to take the death benefits as a lump sum and this would be paid tax-free if Martin had applied for the transitional tax-free amount certificate.  

If Martin hadn’t applied for a transitional tax-free amount certificate, this full lump sum would be liable to income tax at the recipient’s marginal rate, as Martin had no LSDBA allowance left. Alternatively though, if an option, taking the benefits as beneficiary drawdown will mean it is not tested against the LSDBA anyway, irrespective of whether he has a transitional tax-free amount certificate, or not.  

  • As she has crystallised benefits pre-6 April 2024, her LSA/LSDBA will be reduced by (25% x previously used % of lifetime allowance on 5 April 2024 x £1,073,100)  

= 25% x 80% x £1,073,100 
= £214,620 

Her LSDBA will also be reduced by the amount of any serious ill health lump sum paid prior to 6 April 2024. Our assumption for this example, is that she hasn’t had one paid.  

As the actual tax-free cash she took of £200k is less than the £214,620 she will have assumed to have taken, she may wish to apply for a transitional tax-free amount certificate.  

She will have a LSA of £68,275 left if she applies for a certificate. (LSA of £53,655, if she didn’t apply for a certificate).  

However, with a current, uncrystallised fund of £200k, this certificate will not benefit her as she is still restricted to 25% of the uncrystallised fund. So her maximum tax-free cash would be £50k regardless.  

  • Her LSA will be reduced by (25% x previously used % of lifetime allowance on 5 April 2024 x £1,073,100)

= 25% x 55% x £1,073,100
= 25% x £590,205
= £147,551.25

Her LSDBA will also be reduced by £147,551.25 – she hasn’t taken a serious ill health lump sum.

Even though she hasn’t taken any benefits from her PP, the LSA/LSDBA is still reduced by the benefit crystallisation event that occurred when she turned age 75.

As the actual tax-free cash she took of £93,896.25 is less than the £147,551.25 she will have assumed to have taken, it makes sense for her to apply for a transitional tax-free amount certificate.

It’s worth noting that HMRC are considering legislation so the percentage of previously used lifetime allowance on 5 April 2024 doesn’t include any percentage crystallised by BCE 5 or 5B. But this is not the case at the moment.

See question 27 of Lifetime allowance guidance newsletter: March 2024

Disclaimer

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.