Adrian Walker discusses the latest developments surrounding taking tax free cash
Rules surrounding the provision of tax free cash in a lump sum based on contributions made since A-Day have been simplified.
The lump sum, now known as a pension commencement lump sum (PCLS), will be limited to 25% of the fund value built up within a client's registered scheme. This is subject to the fund not exceeding the lifetime allowance.
The Pre Budget Report announced that there will be no increase in the lifetime allowance for the five year period beyond the 2010/11 tax year. This will limit the monetary value of the PCLS to £450,000 (i.e. 25% of £1.8 million lifetime allowance) at the top-end of the savings market. This will have little impact on the majority of clients saving through pension arrangements as it is unlikely they will build funds that threaten the lifetime allowance.
There are wider implications of this announcement for the pension market. Prior to A-Day many individuals accumulated pension rights through membership of occupational pension schemes. Pre A-Day it was possible for clients in these schemes to benefit from a lump sum on retirement that would be greater than 25% of the value of their occupational fund at A-Day.
Fortunately this valuable entitlement was protected under the transition legislation applying at A-Day. For these clients their Pre A-Day pension commencement lump sum will automatically increase in line with the rise in the lifetime allowance.
The freezing of the lifetime allowance as announced in the Pre Budget Report will have a practical impact on the proportion of their ultimate fund which is available as a PCLS.
With recent falls in equity markets, clients may have seen the proportion of their Pre A-Day fund that could be available as a PCLS increase despite a fall in their overall fund value. The lifetime allowance indexation will, until the end of the 2010/11 tax year, increase the monetary value of the A-Day PCLS. By the end of the 2010/11 tax year the cumulative indexation of the Pre A-Day protected lump sum will be 20%.
However this indexation figure will still apply at the end of the 2015/16 tax year while investment values may well have recovered over the same period.
Active investment management of these Pre A-Day funds may deliver some added value to the eventual PCLS that clients with benefits in Pre A-Day occupational schemes are entitled to.
Current legislation provides that, in addition to the basic revaluation of the protected lump sum, an additional lump sum may also be available. This additional lump sum is dependent on whether the A-Day fund outperforms the increase in the lifetime alllowance by the time the client crystallises the benefits in the scheme where a protected PCLS exists.
Where the A-Day fund outperforms the lifetime allowance the client will be entitled to an additional PCLS of 25% of the growth achieved in excess of the increase in lifetime allowance.
Consider for example a client who was a member of a money purchase occupational scheme at A-Day. The value of his fund at A-Day was £100,000. His Pre A-Day cash entitlement was £50,000. If he vests his benefits in the 2011/12 tax year and his fund has grown over the period to £140,000, his available pension commencement lump sum would be £65,000. This is made up as follows:
a) £50,000 x 1.8/1.5 (increase in LTA) = £ 60,000 PLUS
b) 25% of £140,000 (£100,000 x 1.8/1.5) = £5,000
If the eventual value of the fund fell below £120,000 i.e. the A-Day fund plus lifetime allowance revaluation the client would still be entitled to a PCLS of £60,000.
This example highlights the importance that future investment performance will play in delivering the maximum PCLS possible. It also highlights two other important areas of advice that need to be considered in this context, namely, if a transfer to another registered pension scheme is required in order to improve the future investment potential and the possibility of any future contributions being invested.
The protection of the Pre A-Day PCLS on transfer to a new registered pension scheme is available through the use of the 'block transfer' rules. Under these rules two or more members of an existing scheme can elect to transfer their benefits to a new scheme of which they have not been a member for more than 12 months (except where the rights in the personal pension scheme relate to the receipt of contracted-out rebates only).
Alternatively if the scheme is wound-up by the employer, or in the case of a Pre A-Day S32 by the member, the transfer can be made to a post A-Day S32 contract with protection. However, using this option, any subsequent post A-Day transfer will lose the protected Pre A-Day cash rights so care must be taken as to the provider selected.
The question of whether to make ongoing contributions to the same scheme that holds the protected A-Day cash is one that will need individual consideration. Provided that the investment growth of the Pre A-Day fund outperforms the increase in the Lifetime Allowance there will be no problem in doing so. However, if the fund under-performs against the benchmark then the client funding through the same scheme will effectively lose part of their PCLS from any Post A-Day contributions that would be available had the contributions been made to a separate registered pension scheme.
Provided that there is a transfer option available in the Pre A-Day scheme, separate funding could provide an attractive alternative as a performance review could take place nearer to retirement. If out-performance has been achieved, consolidation can then take place before benefits are crystallised. If underperformance has occurred then benefits under each scheme will need to be crystallised separately to maximise the PCLS available to the client.
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