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Tax-free cash protection on transfer

Published  06 April 2024
   5 min read

Some individuals who had been members of occupational pension schemes, section 32 buy-out policies or deferred annuity contracts may have an entitlement to more than 25% of their pre 6 April 2006 benefits value as tax-free cash. This can be lost on transfer.

Here we look at the types of transfer that allow this higher tax-free cash entitlement to be kept.

Key facts

Tax-free cash protection is lost on transfer unless it's one of the following:

  • it's a block (or buddy) transfer
  • it's a wind-up transfer
  • the individual has registered for primary or enhanced protection.

Important note

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

Enhanced protection (EP) — transferring to a new provider

Pension scheme newsletter 157 confirmed that the government would bring forward legislation to provide that individuals with enhanced protection can transfer their pension savings to a new provider and carry over the benefit of their protection, even though their permitted maximums for a lump sum or lump sum death benefit currently operate on a per arrangement basis.

Until the amending legislation is effective, members with enhanced protection may wish to delay transferring to a new provider.

Scheme-specific lump sum protection — calculating a member’s entitlement

Regulation 3 of The Pensions (Abolition of Lifetime Allowance Charge etc) Regulations 2024 made changes to paragraph 24 of Schedule 36 to FA 2004. This provides the calculation for the additional lump sum amount where a member holds scheme-specific lump sum protection. We are aware that this formula double counts certain benefits and therefore does not operate as intended. The government will therefore bring forward legislation to resolve this issue.

Until this legislation is effective, affected members may wish to request a delay to the payment of a PCLS under scheme-specific lump sum protection.

Scheme-specific lump sum protection — reduction to an individual’s lump sum allowance

Pension scheme newsletter 157 confirmed that the government would bring forward legislation to provide that an individual’s lump sum allowance is reduced on the payment of a PCLS under scheme-specific lump sum protection by 25% of the total value of that lump sum plus the pension in connection with which it is paid.

Until this legislation is effective, given the technical error with the formula for calculating the additional lump sum amount, affected members may wish to request a delay to the payment of a PCLS under scheme-specific lump sum protection.

Scheme-specific lump sum protection — transferring providers

Article 23 of The Taxation of Pension Schemes (Transitional Provisions) Order 2006 (SI 2006/572) further modifies the calculation for scheme-specific lump sum protection. This applies in circumstances where members have transferred to a new provider. The government will bring forward consequential legislative changes to amend this calculation in line with amendments to paragraph 34 of Schedule 36 to FA 2004.

Affected members should still be able to transfer their rights to a new provider before the amending legislation is effective. However, given the technical error with the formula for calculating the additional lump sum amount, they may wish to defer the payment of a PCLS under scheme-specific lump sum protection.

 

What is scheme specific tax-free cash protection?

If an individual's tax-free cash entitlement under a registered pension scheme was more than 25% of the benefits value at 5 April 2006, it can be protected through scheme specific tax-free cash protection.

This protected higher pre-6 April 2006 tax-free cash amount is automatically increased by 20%. The growth on the post 6 April 2006 fund may also give rise to additional tax-free cash. 

HMRC Pensions Tax Manual PTM063130: Scheme-specific lump sum protection - overview

Scheme specific tax-free cash protection is lost on transfer unless it's a block (or buddy) transfer or a transfer on wind-up of a scheme.

What is a block (or buddy) transfer?

A block (or buddy) transfer has a number of conditions:

  • More than one member of the scheme must transfer at the same time to the same scheme. A transfer to or from a section 32 plan can’t meet this condition as you can't have more than one member of a section 32 plan. A group personal pension, personal pension, stakeholder pension or an occupational pension scheme under the same trust will be able to have more than one member in it and so a block transfer may be possible.
  • 'Same time' doesn't mean funds have to transfer on the same day, as long as the transfers are obviously meant to be part of the same transaction.
  • All of the individual’s benefits under the scheme have to be transferred - a partial transfer doesn't protect tax-free cash.
  • The individual must not have been a member of the receiving scheme for longer than 12 months unless that scheme is a personal pension (including a stakeholder pension) that has only contracted out rights and they were a member on 5 April 2006.

If these conditions are met any pre 6 April 2006 entitlement to tax-free cash of more than 25% will be maintained under the new plan.

HMRC Pensions Tax Manual PTM062240: Block transfers

Can an individual transfer more than one block transfer into a scheme?

Only one protected tax-free cash amount can be held in a scheme.

If an individual has more than one pension scheme with protected tax-free cash and they block transfer these benefits into the same receiving scheme, the protected tax-free cash amount in the second transfer, and any subsequent transfers, will be lost. 

Example

First transfer from an EPP - transfer value - £500,000, tax-free cash - £350,000 (70%)

Second transfer from a CIMP - transfer value - £100,000, tax-free cash - £80,000 (80%)

Total transfer value - £600,000

When the first amount is block transferred to the new scheme the protected tax-free cash amount of £350,000 is recorded against the scheme. When the second amount is block transferred the second protected tax-free cash amount is lost as only one amount can be held in a scheme, leaving only the original £350,000 protected, a drop of £80,000.

Can another block transfer out be done again?

If the individual’s benefits under a scheme currently has protected tax-free cash due to a previous block transfer-in, and they want to transfer their benefits to another scheme and keep the protected tax-free cash, the block transfer conditions must be met every time they transfer.

What is a wind-up transfer?

This is a specific type of transfer. For a transfer to be treated as a winding-up transfer a number of conditions must apply:

  • the individual has protected tax-free cash, and
  • the existing scheme must be winding up, and
  • the receiving scheme must be a deferred annuity contract, usually a Section 32 plan.

If all of the above conditions are met then any protected tax-free cash will be maintained under the new pension scheme.

HMRC Pensions Tax Manual PTM062240: Winding-up

What about tax-free cash for those with primary protection?

Individuals who had a benefits value at 5 April 2006 of over £1.5 million could have applied for primary protection to reduce or eliminate the chance a lifetime allowance charge could have applied. Individuals had until 5 April 2009 to register for primary protection. The lifetime allowance was abolished from 6 April 2024 and the lump sum allowance and lump sum and death benefit allowance now applies.

If pre-6 April 2006 tax-free cash was less than £375,000 (25% of the lifetime allowance on 6 April 2006) the amount payable is the lesser of:

  • 25% of the benefit value, and
    25% of £1.5 million.

The tax-free cash is protected as a monetary amount if it exceeded 25% of the lifetime allowance on 5 April 2006. Since 6 April 2012 the amount payable is the tax-free cash available on 5 April 2006 increased by 20%.

Their maximum tax-free cash entitlement would have been shown as a monetary amount on their primary protection certificate.

Primary protection and transfers

Transferring pension benefits when an individual has primary protection will not affect their tax-free cash amount. The only exception to this is where someone doesn’t have registered tax-free cash on their primary protection certificate but has scheme specific tax-free cash protection as the normal block transfer and wind-up transfer rules described above will need to apply in order to protect it.

Protecting pre-6 April 2006 benefits 

What about tax free cash for those with enhanced protection?

When it was introduced in 2006 enhanced protection provided full protection from the lifetime allowance charge when individuals took their benefits. There was no minimum benefits value at 5 April 2006 to register for enhanced protection. Individuals had until 5 April 2009 to register for enhanced protection.

Somebody applying for enhanced protection could also apply for primary protection, as backup, if their benefits value exceeded £1.5 million on 5 April 2006.

Until 6 April 2023 there were several events on which individuals could lose their enhanced protection, including if they contributed to any arrangements under a registered pension scheme.

As part of the changes introduced for the abolition of the lifetime allowance, the enhanced protection cessation events were removed from 5 April 2023. As a result, the government introduced a cap on the maximum amount of a tax-free cash these individuals can receive, set at the maximum amount they could have received as at 5 April 2023.

An individual with an entitlement to tax-free cash of more than £375,000 and more than 25% of the fund on 6 April 2006 could retain their tax-free cash entitlement. Their maximum tax-free cash entitlement would have been shown as a percentage on their enhanced protection certificate.

Since 6 April 2023 their tax-free cash is still based on this percentage. However, the percentage is applied to their total benefits value on 5 April 2023.

An individual with an entitlement to tax-free cash of more than 25% of their benefits value on 6 April 2006 but less than £375,000 couldn't protect the tax-free cash amount using enhanced protection. However, scheme specific tax-free cash protection may apply.

Enhanced protection and transfers

Transferring pension benefits when an individual has enhanced protection will not affect their tax-free cash amount. The only exception to this is where someone doesn’t have registered tax-free cash percentage on their enhanced protection certificate but has scheme specific tax-free cash protection as the normal block transfer and wind-up transfer rules described above will need to apply to protect it.

When doing a transfer with enhanced protection you need to be careful that it is a permitted transfer.

HMRC Pensions Tax Manual PTM092420: Enhanced protection - transfers

One final point to bear in mind.

As well as all the conditions explained above, the receiving scheme/insurer must be willing and able to accept the transfer.

Note

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.