Some life offices are attempting to provide clients with a way of 'having their cake and eating it' when it comes to taking tax-free cash.
Scottish Equitable has highlighted a growing number of enquiries asking about the possibility of taking tax-free cash for a pension and then transferring the remaining funds, without going into an unsecured pension (USP) to another provider or scheme which offers USP.
It seems people have become confused over what actually happens to a pension when tax-free cash is taken, but according to HM Revenue and Customs (HMRC) a pension commencement lump sum (PCLS) can only be taken if a member is entitled to a “relevant pension” including USP.
But if the member only takes the PCLS and not the “relevant pension”, transferring the remaining funds, this will mean the PCLS is classed as an unauthorised payment and “taxed accordingly” which could be up to 70%.
However. although the majority of life companies agree with this interpretation of the law, some believe they have found a way to provide an opportunity for members to have the best of both worlds.
The majority of enquiries seem to come from those in deferred annuity or Section 32 (S32) plans, or executive personal pensions (EPPs) where they have an entitlement to more than 25% tax free cash, which would be lost on a transfer to another scheme, but where they don’t have access to income drawdown.
But Dave Lowe, pensions management director at Zurich, says there were discussions with HMRC around six to nine months ago about the possibility of paying out a PCLS and then transferring the remaining funds into a nil rate of income USP, without ever being able to increase the limit above zero.
This would allow companies who don’t have the systems to cope with USP arrangements, and allow members to go into USP without the problems of trying to make payments, and giving the member the option and flexibility to transfer into a scheme which offers full USP on a straightforward transfer.
However, Lowe points out HMRC rules on USP transfers do require the funds to physically move into a USP contract before they can be seen as active, which means schemes may have to change their rules to allow this, which some might not be willing to do.
But if the scheme can or will change its rules to accommodate a nil-rate USP, Lowe says this is one of the devices for maintaining protection, and although Zurich has a USP contract and can offer this facility, it is not an area it is actively promoting.
He says: “Although there is quite a lot of business going on in this area, as it could be of interest to some individuals, there are concerns somebody taking a PCLS early, with say 10 years left to retirement, they may find they are left with a smaller fund than they imagined.”
Lowe says while Zurich is looking into these kind of spaces to see if there are any good opportunities, at the moment it would not actively pursue any business in this area of transfers.
Rachel Vahey, head of pension development at Scottish Equitable, says the actual process of doing this is not that difficult for life companies, but it would require a change to the rules and would involve issuing information and communications to the members.
She says: “This is what we have in place for our EPPs and S32s we changed our rules to allow USP on these products which makes it much easier for people to transfer if necessary. It’s not that difficult to do but it does need a bit of work.”
Vahey points out this is particularly true of schemes which didn’t change its rules straight away for a specific reason, such as not having the systems to cope with USP payments and arrangements.
She adds: “Members have to make sure the provider has, or will, make the necessary changes to the scheme rules, as even if the USP is not meant to make any payments, it still requires a lot of work, and if it is not done properly people could still be hit with the unauthorised payment charge.”
But Mike Morrison, pensions strategy director at Winterthur Life, says he is surprised there has been any real confusion over this issue, as it seems the rules have been pretty clear even before A-Day that taking tax free cash means you are vesting your rights.
He points out this could be a particular problem for death benefits, as if a member is considered to have died before vesting their rights, such as transferring funds so the PCLS is classed as an unauthorised payment, then death benefits could be subject to an additional charge of 35%.
However he says: “It is good to see some life offices are being pragmatic about this issue and finding ways of helping the members to do what they want. But it is very important to make sure any transfers are treated as a vesting of rights or there could be unforeseen consequences.”
One IFAonline reader, who is aware of at least one other life office other than Zurich offering these facility for members, says: “If they can do this perhaps other providers should introduce this flexibility to their occupational pension schemes as well. It seems to be an excellent way to work around the "simple" new rules.”
However, HMRC does not seem to join in the enthusiasm, as it seems to take the view that offering USP with nil rate income is a legitimate way of transferring funds and keeping a higher tax free cash entitlement.
Patrick O’Brien, spokesman for HMRC, says a PCLS can only be paid where the member becomes entitled to a "relevant pension" under the scheme and a "relevant pension" includes amongst other things, income withdrawal.
But he warns: “If the member is not entitled to take income withdrawals from the USP fund under the scheme, then funds are not available for the payment of a “relevant pension” under that scheme and so any lump paid will not be a PCLS, it will be an unauthorised payment.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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