- There is a new formula for calculating scheme protected tax-free cash (SSPTFC)
- The order of taking tax-free cash from multiple schemes is important
- Knowledge in this area shows the value of your advice
Please be aware, this article does not reflect the updates from pension newsletter 159. It will be updated shortly.
Key takeaways from this article
From 6 April 2024 HMRC has laid out they intend to simplify the calculation for scheme specific protected tax-free cash (SSPTFC). They will do this by removing the link to lifetime allowance. Unfortunately in making the legislation they have made a mistake in the formula which means it doesn’t work. They are aware of this error and have said they will bring forward regulations to correct the error. They advise that until this is fixed, clients should not request to take a SSPTFC lump sum. The rest of this article is based on what we believe the will correct the formula to say.
Where the client holds uncrystallised rights in multiple schemes, the order of crystallisation is very important for maximising tax-free cash for clients where at least one of the schemes has SSPTFC. Knowledge in this area shows the value of your advice.
1. Comparison of old vs new formula
Previous formula
(1) Tax-free cash on 5/4/06 x (£1,800,000/£1,500,000) +
(2) Current fund value - (fund value on 5/4/06 x (Current lifetime allowance/£1,500,000) x 25%) – (transfer out x 25%)
New formula
(1) Tax-free cash on 5/4/06 × 1.2] +
(2) Current fund value* - ((fund value on 5/4/06 x 0.7154) x 25%) – (transfer out x 25%)
You can see here that the revaluation of the a-day fund value is multiplied by a factor of 0.7154 instead of being revalued by the change in the lifetime allowance. This is an advantage to people holding Fixed or Individual Protection.
*HMRC has acknowledged the formula in the FA 2024 is flawed and will be updated. This is what we believe it will be updated to.
2. How SSPTFC works with the tax-free allowances
Unlike a standard pension commencement lump sum (PCLS), a scheme specific protected lump sum is not limited by reference to the client’s remaining Individual’s Lump Sum Allowance (ILSA), but according to the HMRC pension tax manual (this is not currently reflected in legislation), it is limited by remaining Individual’s Lump Sum and Death Benefit Allowance (ILSDBA). However because it is still a type of PCLS, the overarching rule that you must have all or part of your allowances available to be able to take a PCLS still apply. So there will need to be at least £1 of ILSA to be able to take SSPTFC and the tax-free amount will be limited by ILSDBA.
The permitted maximum for a PCLS (the limit on how much is tax-free) is the scheme specific protected amount as per the above formula (as long as there is sufficient remaining ILSDBA). Therefore, if there is more than one pension scheme, where you take tax-free cash first can effect the total amount of tax-free cash you can take across all pensions. This is because, the act of taking SSPTFC uses up both ILSA and ILSDBA.
For ILSA, HMRC have made an error in the wording on the legislation and are aware of this error. They have said they will bring forward regulations to correct the error. They advise that until this is fixed, clients should not request to take a SSPTFC lump sum. We believe that what they intend to regulate is that ILSA is reduced by 25% of the total fund being used to provide a SSPTFC and connected pension (so the full uncrystallised fund value). ILSDBA will be reduced by the total tax-free amount.
3. Taking benefits from multiple schemes
Where there are multiple schemes and you will exceed your ILSA, the order you take benefits will affect the total amount of tax-free cash you can take. As long as there is some available ILSA and sufficient remaining ILSDBA after taking TFC from other schemes you should take your SSPTFC last to maximise the amount you can take tax-free. This can be demonstrated in the below example.
Example
Client has two schemes A and B -
- Scheme A - worth £600k with SSPTFC of 300k as per the formula
- Scheme B – worth £750k with no PTFC
|
Standard permitted maximum |
SSPTFC permitted maximum |
|
The lower of:
|
The scheme specific protected amount as per the formula ( as long as the member has some available ILSA and sufficient remaining ILSDBA). |
As you can see from this example, the order that TFC is taken, can make a material difference to the total TFC. Therefore you can show your value your clients by maximising the amount of tax-free cash they can take by choosing the correct order.
Additional Technical Support
If you have a question that was not covered online, our expert team would be pleased to help. Simply click the button below, fill in the form and our technical team will aim to be in touch within 48 hours, between 8.30am-4.30pm, Monday-Friday. Or call the team on 02380 726010.
The information provided in this article is not intended to offer advice.
It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.