What is scheme specific tax-free cash protection?

If an individual's tax-free cash entitlement under a registered pension scheme (such as an occupational pension scheme, Section 32 buy-out policy or deferred annuity contract) was more than 25% of the benefits value on 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.

The exact formula to use can be found in later in this article under the section - How is the tax-free lump sum calculated?

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.

Scheme-specific tax-free cash protection is retained to a certain degree if only part of the protected scheme is transferred. The transferred portion won't be protected, but the remaining funds will keep the protected tax-free cash, but it will be decreased by 25% of the value that was transferred out.

What is a block (or buddy) transfer?

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

• More than one member of the same 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 if the transfers are obviously meant to be part of the same transaction.
• All the individual’s benefits under the scheme must 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, and the receiving scheme accepts protected tax-free cash, any pre-6 April 2006 entitlement to tax-free cash exceeding 25% will be preserved under the new scheme.

HMRC Pensions Tax Manual - PTM063150: Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: scheme-specific lump sum protection - transfers and winding-up 

HMRC Pension Tax Manual - PTM062240: Member benefits: pensions: protected pension age: right to keep a protected pension age after transfers or winding-ups

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 scheme receiving the transfer must be a deferred annuity contract, usually a Section 32 plan. 

If all the above conditions are met, any protected tax-free cash will be maintained under the new pension scheme. 
 
HMRC Pensions Tax Manual - PTM062240: Member benefits: pensions: protected pension age: right to keep a protected pension age after transfers or winding-ups

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

Individuals who had a benefits value on 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. Although the lifetime allowance was abolished from 6 April 2024, having primary protection can have an impact on the individual’s lump sum allowance and lump sum and death benefit allowance. 
 
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 lower of: 

• 25% of the benefit value when benefits are taken, and 
• 25% of £1.5 million (£375,000)

The tax-free cash is protected as a monetary amount if it exceeded 25% of the lifetime allowance on 5 April 2006. The protected tax-free cash entitlement, if it applies, will be shown as a monetary amount on the primary protection certificate. 

Since 6 April 2012, the amount payable is the tax-free cash available on 5 April 2006 increased by 20%. 
 

Primary protection and transfers 

Transferring pension benefits when an individual has primary protection will not affect the tax-free cash amount they can be paid. 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. In this case, the normal block transfer and wind-up transfer rules described above will need to be complied with 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 on 5 April 2006 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 that would cause individuals to 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, where the enhanced protection was applied for before 15 March 2023, and a certificate or reference number subsequently issued.

As a result, the government introduced a cap on the maximum amount of tax-free cash these individuals can receive, set at the maximum amount they could have received as of 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 5 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 5 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 and has registered tax-free cash on their certificate (so had more than £375k tax-free cash on 5 April 2006) will not usually affect their tax-free cash amount. Where someone doesn’t have registered tax-free cash percentage on their enhanced protection certificate but has scheme specific tax-free cash protection, similarly to primary protection, the normal block transfer and wind-up transfer rules described above will need to be complied with in order to protect it.
 
When doing a transfer with enhanced protection you need to be careful that it is a permitted transfer (This would only be relevant since 6 April 2023, where they hadn't applied for the enhanced protection before 15 March 2023, and a certificate or reference number subsequently issued).

HMRC Pensions Tax Manual - PTM176310: Lump sum and lump sum and death benefit allowance: Enhanced protection 

At a glance

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.

Stand-alone Lump Sums

Some individuals had the right to take 100% of the fund value as TFC. These rights could also be protected post 6 April 2006 as stand-alone lump sum (SALS) protection.

SALS protection allows the individual to take all their pension plan as TFC, so long as the following conditions are met:

1. the individual has reached the normal minimum pension age, or any earlier protected pension age they may have under the scheme.
2. all the individual’s rights under the scheme are crystallised in one go.
3. there have been no contributions paid (or relevant benefit accrual for a DB scheme) to the scheme after 5 April 2006.
4. the individual did not have lump sum rights of more than £375,000 on 5 April 2006 where either primary or enhanced protection applies when the lump sum is paid (if the individual did have lump sum rights of more than £375,000 on 5 April 2006, see below.

From 6 April 2023

From 6 April 2023 the maximum tax-free stand-alone lump sum is limited to the value of the benefits on 5 April 2023. Where a stand-alone lump sum is paid that exceeds the value of the benefits on 5 April 2023, the excess is treated as pension income and is taxable at the recipient’s marginal rate of income tax.

From 6 April 2024

Where the individual has Primary Protection, but not Enhanced Protection and, on 5 April 2006, had lump sum rights exceeding £375,000, the maximum tax-free Stand-alone Lump Sum (SALS) is limited to the lower of:

• the individual’s available Lump Sum and Death Benefit Allowance (LSDBA) immediately before the individual becomes entitled to the SALS; and
• the maximum tax-free SALS that the individual could have been paid on 5 April 2023.

Where the individual has Enhanced Protection and, on 5 April 2006, had lump sum rights exceeding £375,000, the maximum SALS is limited to the maximum tax-free SALS that the individual could have been paid on 5 April 2023 under the arrangement, *minus the total of any PCLS and any SALS paid to the individual under the arrangement on or after 6 April 2023.

Where the individual has neither primary nor enhanced protection the maximum tax-free stand-alone lump sum is limited to the value of the benefits on 5 April 2023.

Any amount paid higher than the above limits are taxed as pension income on the excess.

*This is legislation. However, as you will note from the conditions above, an individual must take all their benefits from the scheme. So, they’ll not actually be able to take PCLS or a SALS from an arrangement after 6 April 2023 and still have an entitlement to a SALS from that arrangement.

One last 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. 

HMRC Pension Tax Manual - PTM063130: Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: scheme-specific lump sum protection - overview

What are the conditions for paying a scheme specific tax-free lump sum? 

The first is that the lump sum must be paid from the scheme that held the right on 5 April 2006, the original scheme. Or from another registered pension scheme where the right to have a scheme specific tax-free lump sum was transferred as part of a block transfer. 

The most important condition is the individual must become entitled to all their pension savings under the scheme on the same day. This seems to be easy to comply with however, it is vital that checks are made to see if the individual has more than one arrangement in the scheme. This is especially the case where the lump sum is being paid from a provider’s personal pension scheme or master trust. All benefits held in all arrangements in that scheme must be paid out at the same time. 

Where a scheme-specific tax-free lump sum is paid in connection with two or more pension types (defined benefit scheme pension, money purchase scheme pension, or a lifetime annuity) from the same scheme, the usual requirement to take all benefits on the same date is relaxed. Instead, all related pensions must start within six months of the first pension coming into payment. The protected lump sum can then be paid within the normal 18-month period, measured from the date the member becomes entitled to the last of the associated pensions. 

Scheme specific tax-free lump sum and trivial commutation. 

Where payment of a scheme-specific tax-free lump sum leaves only a small residual benefit, the remaining rights may be paid as a special form of trivial commutation lump sum rather than providing a pension. This allows all benefits under the scheme to be taken as lump sums, subject to strict conditions. 

The remaining benefits must be £10,000 or less, paid within one month of the protected PCLS, extinguish the member’s remaining rights under the scheme, and meet the relevant age or ill-health conditions. The scheme-specific tax-free lump sum is paid tax-free (subject to available lump sum allowance), while the trivial commutation lump sum is taxable as pension income. If the conditions cannot be met, the maximum protected PCLS may need to be reduced so that part of the benefits can be paid as a pension.

How is the tax-free lump sum calculated? 

The formula is: 

Protected tax-free lump sum on 5 April 2006 x 1.2 + (current fund value – (fund on 5 April 2006 x (member's LSDBA* / £1,500,000)))/4.

*This is their initial lump sum and death benefit allowance without any adjustment for benefits taken pre-6-April 2024 or tax-free benefits taken on or after 6 April 2024.

Individuals must become entitled to all their pension and tax-free lump sum rights (that were not in payment on 5 April 2006) under the scheme on the same day.

The scheme specific tax-free lump sum must be taken in connection with a relevant pension (so a drawdown plan, scheme pension or a lifetime annuity) or in connection with a trivial lump sum. 

See: HMRC Pensions Tax Manual - PTM063130: Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: scheme-specific lump sum protection

The formula is the same for money purchase and defined benefits schemes but how it is applied in practice is different. 

Money purchase schemes

This is calculated in 2 parts, the pre-6 April 2006 benefits and the post 6 April 2006 benefits. 

The first part of the formula is in respect of the pre-6 April 2006 benefits. This is basically the pre-6 April 2006 tax-free lump sum entitlement increased by 20%.

The second part of the formula is used to calculate the individual's tax-free lump sum entitlement on their post 6 April 2006 benefits. This is 25% of the fund growth since 6 April 2006 but with the fund value on 6 April 2006 adjusted. The adjustment factor is their lump sum and death benefit allowance/£1,500,000.

It's possible this part of the formula produces a negative figure or zero. The most common reason for this is if no contributions have been paid into the plan post 6 April 2006 and there's been little or no investment growth. If the figure is negative, use a figure of zero.

Here's an example of the calculation:

Lump sum and lump sum and death benefit allowances 

Before 6 April 2024, benefits were tested against the lifetime allowance when a benefit crystallisation event occurred. Benefits exceeding the remaining lifetime allowance were subject to a tax charge. 

Since the abolition of the lifetime allowance on 5 April 2024, it is only tax-free lump sums that are tested.  They are tested against the new lump sum allowance and the lump sum and death benefit allowance. See our article Lump sum allowance and lump sum and death benefit allowance for full details of what is tested against each. 

Unlike individuals with lifetime allowance protection, individuals with scheme specific tax-free lump sum entitlement do not have an increased lump sum allowance and lump sum and death benefit allowance.  To ensure they are not penalised for getting a tax-free lump sum over 25%, the way the tax-free element is deducted from the new allowances is different for them. 

Lump sum allowance 

Only 25% of the value of the benefits crystallised is deducted from the lump sum allowance, not the amount of tax-free lump sum paid. There is no requirement for the individual to have any lump sum allowance remaining for the lump sum to be paid. It is for this reason that care should be taken when deciding the order that other benefits should be taken if a scheme specific tax-free lump sum is being paid. 

Lump sum and death benefit allowance 

The individual must have available lump sum and death benefit allowance remaining when the lump sum is paid. The full amount of the tax-free lump sum paid is deducted from the lump sum and death benefit allowance. 

What if the tax-free lump sum is more than the available lump sum and death benefit allowance? 

With scheme specific lump sum protection, it's possible to pay a tax-free lump sum of more than an individual’s available lump sum and death benefit allowance. They don’t need to have any remaining lump sum allowance. 

If the value of the proposed lump sum is greater than the amount of the individual’s available lump sum and death benefit allowance, the whole tax-free lump sum can still be paid as a pension commencement lump sum. 

However, the part of the pension commencement lump sum in excess of the individual’s lump sum and death benefit allowance is subject to income tax at their marginal rate of tax. 

There is no tax charge if the scheme specific tax-free amount is in excess of the lump sum allowance but below the individual’s remaining lump sum and death benefit allowance. 

Does everyone have the same amount of lump sum and death benefit allowance?

The level of an individual’s remaining allowance depends on whether they have lifetime allowance protection and/or an enhancement factor, the form of that protection and whether they have taken benefits before 6 April 2024 and taken tax free benefits on or after 6 April 2024. 

No lifetime allowance protection or enhancement factor 

If the individual has no lifetime allowance protection, their available lump sum and death benefit allowance is based on the standard lump sum and death benefit allowance (£1,073,100). 

Enhanced protection but no registered tax-free lump sum 

If the individual has enhanced protection and no registered tax-free percentage on their enhanced protection certificate. This would be the case if on 6 April 2006 they had an entitlement to a tax-free lump sum of more than 25% of their benefits value but less than 25% of the lifetime allowance (£375,000).  Their lump sum and death benefit allowance is the value of their uncrystallised funds under the arrangement on 5 April 2024. 

Other lifetime allowance protections 

If the individual has another form of lifetime allowance protection, their lump sum and death benefit allowance is based on the level of their protected lifetime allowance, for example: £1.5 million for fixed protection 2014. 

Enhanced with protected tax-free lump sums 

If the individual has enhanced protection with a registered tax-free percentage on their enhanced protection certificate, they cannot be paid a scheme specific tax-free lump sum.  This is because their maximum tax-free lump sum entitlement is the percentage, shown on their certificate. This percentage is applied to their total benefits value on 5 April 2023 under an arrangement. 

For example, the standard lump sum and death benefit is £1,073,100, and the individual has already had relevant benefit crystallisation events from another pension scheme using up £643,860 of their lump sum and death benefit allowance, their available remaining lump sum and death benefit allowance is £429,240.  

Enhancement factor 

If the individual has an enhancement factor and no other lifetime protection, their initial lump sum and death benefit allowance will be calculated by £1,073,100 + (£1,073,100 x EF) where EF is the enhancement factor. 
Where the individual has lifetime allowance protection as well as an enhancement factor, then the following guidance confirms how the initial lump sum and death benefit allowance should be calculated, based on what protection they have.

HMRCs Pensions Tax Manual - PTM175500: Lump sum allowance and lump sum and death benefit allowance: Enhancement factors: Applying enhancement factors at relevant benefit crystallisation events