Tax-free cash

With lifetime allowance protection, as well as scheme protected tax-free cash, there are now many different ways in which an individual’s maximum tax-free cash (TFC) might be calculated. This article is designed to summarise the calculations for each circumstance.

These are not comprehensive notes.

Additionally, some people had accrued a tax free cash entitlement under the old pension legislation that exceeded 25% of the fund value, and rules were introduced to protect affected individuals, either by way of protection of the larger TFC entitlement within a particular pension scheme, or by way of protection of a larger TFC entitlement by way of lifetime allowance protection (Enhanced Protection, or Primary Protection). 

Aspects that may affect the general rule

Having a protected lifetime allowance and/or protected tax-free cash may affect the general rule above for the provision of tax-free cash from a registered pension scheme.

Note that:

• The TFC referred to in this article is a pension commencement lump sum (PCLS); and
• An individual must have available standard lifetime allowance to be able to be paid a PCLS unless the individual has protected TFC via Primary Protection, or protected TFC via Enhanced Protection

Where there is protected tax-free cash

Protected TFC via Scheme Protection

Many people had built up an entitlement to TFC that was greater than 25% in a particular pension scheme prior to the inception of Pension Simplification on 6 April 2006. For these members not to be disadvantaged by the new pension rules, legislation was introduced to protect this level of TFC within their pension schemes going forward until benefits were taken. There were certain restrictions on how this protection would be maintained when pension rights are transferred between schemes (block transfers and scheme wind ups).

The protected TFC available at A Day is recorded by the scheme as a monetary amount.

When the member subsequently decides to take their pension benefits the amount of TFC that can be paid will be calculated at that point. There are two elements to this calculation:

• Revalue the A-Day protected cash value by 20%, and
• Calculate an additional lump sum allowance (ALSA), which is 25% of the growth in pension rights since A-Day as calculated by a specific formula.  

The formula for the calculation of the additional lump sum amount (ALSA) is:

ALSA = A – (B x C / D) where:

• A is the current value of the member’s rights in the scheme (e.g. the current fund value in a money purchase pension scheme);
• B is the value of the member’s rights in the scheme on 05/04/2006 (e.g. the fund value on that date in a money purchase pension scheme);
• C is the current lifetime allowance; and
• D is £1.5m, the value of the lifetime allowance on 06/04/2006

The value used as current lifetime allowance in the formula above depends on the type of lifetime allowance (LTA) protection the individual has, as detailed below.

Examples

An individual has a money purchase pension with an A Day protected TFC sum of £80,000 and an A Day fund value of £200,000. The individual is looking to take his benefits in the tax year 2021/22 with a standard LTA of £1,073,100 and a current fund value of £300,000.

The calculation of the maximum TFC that can be paid to the individual will be done in 2 parts:

1. Increase A-Day TFC sum of £80,000 by 20%. The result is £96,000;
2. Calculate ALSA. The calculation of ALSA will be different, depending on the type of lifetime allowance the individual has:

The maximum TFC available to the member will be £96,000, plus the calculated amount of ALSA. For example, if the individual had Fixed Protection 2012, their maximum TFC would be £110,100 (£96,000 plus £15,000).

Protected TFC via Enhanced Protection

Any client who has Enhanced Protection whose entitlement to TFC from all schemes on 05/04/2006 was greater than £375,000 will have that entitlement recorded on their Enhanced protection certificate as a percentage. The percentage figure recorded will identify the amount that can be taken as TFC from each scheme held by this client.

Subsequent changes in the LTA have no effect on this entitlement.

Protected TFC via Primary Protection

An individual with protected TFC under Primary Protection is not limited to a percentage of TFC when taking benefits but does have an overall monetary limit beyond which TFC may not be paid.

Protected TFC under Primary Protection was given as a monetary amount on any Primary Protection certificate that was issued. If there was no monetary amount stated, no protection had been granted.

Any monetary amount would have been increased in line with the increase with the LTA and this will apply to the LTA increases up to £1.8 million. However, due to the consequences of the changing legislation this TFC value may vary depending on circumstances and may be revalued.

First BCE and TFC sum paid after 6 April 2014
The available TFC figure stated at A Day will be increased in line with the increase in the LTA to £1.8 million (i.e. increased by 20%. Example: TFC at A Day of £500,000 would be increased by 20% so £500,000 x 1.2 = £600,000).

Previous BCE with TFC before 6 April 2014 and next BCE after 6 April 2014
In these circumstances you will still increase the original protected monetary amount by 20%. However, for the pre 6 April 2014 monetary sum taken as TFC you will apply the formula of: £1.8/the LTA applicable at the prior BCE. Once this calculation has been done (providing a slightly larger TFC monetary amount), this sum will be taken away from the increased original protected monetary amount and this will give you the available TFC sum left for any future TFC payments.

Example

These calculations will have to be done for each event the client has where TFC is being taken. The formula will always start with the figure of £1.8 million until such time as the prevailing standard LTA exceeds this figure.

Where there is not protected tax-free cash

No lifetime allowance protection and no protected TFC

The maximum TFC will be the lower of: (i) 25% of the amount crystallised at a retirement BCE; and (ii) 25% of their available standard lifetime allowance (currently £1,073,100).

Lifetime allowance enhancement factor and no protected TFC

The maximum TFC will be the lower of: (i) 25% of the amount crystallised at a retirement BCE; and (ii) 25% of their available standard lifetime allowance (currently £1,073,100).

Enhanced and/or Primary Protection with no Protected TFC

For individuals with Primary or Enhanced Protection and no TFC protection, the maximum TFC they may be paid will be the lower of: (i) 25% of the amount crystallised at a retirement BCE; and (ii) 25% of their available lifetime allowance. For this purpose only, their lifetime allowance is deemed to be £1.5m.

The prevailing standard lifetime allowance (currently £1,073,100) is used for the purpose of whether or not the individual has available lifetime allowance for the purpose of being paid a PCLS.  It is possible for an individual to have a maximum TFC sum they may be paid but fail to meet the conditions to be paid a PCLS and so be unable to have any TFC.

To calculate their available lifetime allowance for the purposes of the maximum TFC they may be paid, first any amounts of lifetime allowance used up (crystallised) when benefits were previously taken (a prior event) are identified.

Next, those amounts are adjusted to consider changes in the standard lifetime allowance over time. This adjustment is made using the formula:

• Amount crystallised at prior event x (CSLA / PSLA)

In the above, the value used as CSLA and PSLA depends on the date of the prior event.
If the prior event took place between 06/04/2006 and 05/04/2014 inclusive, then:

• CSLA is the current standard lifetime allowance; and
• PSLA is the standard lifetime allowance at the time of the prior event

However, if the previous event took place on/after 06/04/2014, then:

• CSLA is the greater of: (i) the current standard lifetime allowance; and (ii) £1.5m; and
• PSLA is the greater of: (i) the standard lifetime allowance at the time of the prior event; and (ii) £1.5m

Finally, the adjusted amounts are deducted from £1.5m to determine the available lifetime allowance for the purposes of the 25% maximum lump sum rule.

Fixed and Individual Protection with no Protected TFC

The principle of the TFC available at each benefit crystallisation event (BCE) being the lower of (i) 25% of the individual’s available lifetime allowance, or (ii) 25% of the value being crystallised at the BCE applies.

The individual’s lifetime allowance protection will determine the lifetime allowance on which their available lifetime allowance will be based. For:

Summary Table

* If revalued protected tax free cash exceeds the value of the pension fund a small amount of the fund must be used to provide a pension benefit which could itself be taken as a trivial taxable lump sum.
** For the purpose of determining whether there is any remaining lifetime allowance to pay the protected tax free cash lump sum the remaining lifetime allowance is their based on their personal lifetime allowance which may be more than the standard lifetime allowance.

Updated December 2021