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Technical View

Revisiting protected tax free cash sums - when to crystallise?

Whilst 6 April 2018 brings with it the first increase in the Lifetime Allowance (LTA) for eight years Julia Peake of Sanlam UK, looks at  scheme specific lump sum rights which may reduce as a result of the forthcoming increase in the LTA and so some clients may wish to crystallise before the end of this tax year.
Back in 2006, A-day brought about pension simplification and an end to some of the complexities of previous regimes.  Today’s pension environment includes pension freedoms, a flat 25%  tax-free cash and auto-enrolment, compared to the pre A-day scenario where, in broad terms, occupational pension schemes benefits were restricted by revenue maxima limits and in personal pension schemes the contributions were limited. In pre A-day occupational pension schemes and deferred annuity contracts, such as Section 32 contracts, these calculations often provided for tax-free cash sums in excess of 25% and could even be 100%.   These could be protected from A-Day as long as certain conditions were met.
In another part of the pensions’ world, the Lifetime Allowance (LTA), which was introduced from A-day at £1.5m has fallen substantially since the dizzying heights of £1.8m in 2010.  Three consecutive reductions have left it at a comparatively low £1m but, as confirmed in the Autumn Budget 2017, the first rise is now imminent as it increases in line with the increase in CPI. We will therefore see a 3% increase to an LTA of £1.03m from 6 April 2018.
So, what does the relationship between the LTA and scheme specific protected lump sum rights mean for clients with a protected tax free cash sum? The example below aims to shed some light

Case Study – Scheme-Specific Tax-free cash

Mr Jones had a Section 32 contract valued at £300,000 with a tax-free cash entitlement of £150,000 as at A-day. To calculate what this is worth to Mr Jones if he crystallises all these pension scheme benefits in this tax year, a two-stage calculation needs to be completed:

  1. Mr Jones’ tax-free cash sum as at 5 April 2006 is revalued by 20% (being the increase in the LTA as at A-day of £1.5m, and the underpinned LTA of £1.8m used in this part of the calculation formula).
  1. An additional amount of tax-free cash representing 25% of the increase in value of the pension fund since 6 April 2006. This is applied after proportioning down the fund value as at 6 April 2006 to reflect the reduction in the LTA to below its value at 6 April 2006, and paid as a lump sum.

Mr Jones’ scheme-specific tax-free cash

Value of fund @ 5 April 2006 £300,000
Scheme specific tax-free cash @ 5 April 2006 £150,000
Value of fund today £ 380,000
Step 1   £150,000 x 120% (£1.8m / £1.5m) £    180,000
Step 2 (£380,000 - [£300,000 x £1.0m/£1.5m]) x 25% £    45,000
  Total: £  225,000

An Opportunity?

As the LTA is increasing to £1.03m from 6 April 2018 and assuming no further investment growth, Mr Jones’ tax free cash sum will reduce in Step 2 of the calculation as the £1m is substituted by £1.03m. As a result £45000 in the above example becomes £43,500.
In order to avoid an increasing LTA adversely affecting his tax-free cash, Mr Jones can crystallise all his benefits under the Section 32 in this tax year by taking the tax-free cash and designating the remainder of the fund to flexi-access drawdown.

Final thought

By and large the Chancellor left pension policy alone in his most recent Budget, but this does not mean that there will not be changes in the future as the government looks to stabilise the UK balance sheet. While there are always rumours about what these changes could be, any recommendations given should be on facts at the time rather than conjecture and specific to your client’s aims and objectives.

This note is to be used by Financial Advisers only. It is not intended for onward transmission to a private customer and should not be relied upon by any other person. Sanlam accepts no liability for any action taken or not taken by an individual or firm as a result of the contents of this material. The tax treatments and information contained in this document are based on current tax law and HMRC practice as at February 2018 and may be subject to change in the future. Whilst we have made every effort to ensure the accuracy of this material, we cannot accept responsibility for any consequence (financial or otherwise) arising from relying on it. This document is for information purposes only and should not be treated as advice and independent taxation advice should always be sought.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.