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Adviser  >  Technical Central  >  Pre simplification  >  Transfers  >  Tax-Free Cash Entitlement When A Transfer Value is Split

Tax-Free Cash Entitlement When A Transfer Value is Split

The content of this page is based on our understanding of how pensions worked before A-Day, the 6 April 2006, and is provided for reference only.

When a member of an occupational pension scheme transfers their benefits, it is possible for the transfer to be fragmented i.e. part of the transfer value is paid to a ‘s32’ buy-out and part paid into a personal pension plan.

The tax-free cash entitlement payable under each of the new plans depends on whether a member is a Regulated Individual or not.

A Regulated Individual is a person:

  • who is, or was in any of the 10 years prior to the date on which the transfer is made, a controlling director and/or
  • who is, or was, earning more than 100% of the current earnings cap in the current or any of the previous 6 years, AND are age 45 or over at date of transfer.

So what tax-free cash is payable, and from where? The two different scenarios are explained below:

Regulated individual

When the transfer value is split between two plans the amount of the certified tax-free cash must also be split in proportion to the amount of each transfer payment. This rule even applies if all of the contracted-out benefits are transferred to one plan and the additional rights are transferred to another plan. This would effectively mean that the member would be reducing their tax-free cash entitlement as in practice no tax-free cash can be taken from the protected rights part of a fund. This will change after A-Day (6 April 2006) when, subject to DWP confirmation, up to 25% of the protected rights fund can be taken as tax-free cash.

Example

Leo is a controlling director, therefore his tax-free cash must be certified. He has a transfer value of £150,000 of which £20,000 is in respect of protected rights and a certified tax-free cash amount of £30,000.

If the transfer is split:

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

£50,000 (including £20,000 protected rights)

£100,000

then the tax-free cash will be split: 

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

£30,000 x £50,000 =£10,000
               £150,000

£30,000 x £100,000 = £20,000
                 £150,000

At retirement the total amount of tax-free cash derived from the transfer must be the lesser of:

  • 25% of the accumulated fund from the transfer excluding the protected rights part;
    and
  • the certified amount index linked by RPI for the period since the transfer.

After A-Day, subject to DWP requirements, up to 25% of the total fund can be taken as tax-free cash.

The tax-free cash can be increased by RPI from date of transfer (or leaving in the case of a transfer from a scheme in which the member is a deferred member) to retirement.

Non-Regulated individual

Where a transfer value for a non-regulated individual is split between a personal pension plan and a ‘s32’ buy-out, the maximum amount of tax-free cash that can be paid from the personal pension plan is 25% of the non-protected rights fund (this assumes that the transfer is not subject to a nil certificate). The maximum amount of tax-free cash that can be paid from the ‘s32’ buy-out is split in proportion to the transfer value.

Example

Jacob has a transfer value of £100,000. Jacob could take £20,000 tax-free cash if he remains in the occupational pension scheme.

If the transfer is split:

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

£60,000 

£40,000

then the tax-free cash will be split: 

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

£60,000 x 25% = £15,000

£40,000 x £20,000 = £8,000
£100,000

The tax-free cash can be increased by RPI from date of transfer (or leaving in the case of a transfer from a scheme in which the member is a deferred member) to retirement.

Another option available to non-regulated individuals is to transfer all of their protected rights benefits to one policy and all the additional rights benefits to another. In these circumstances, the policy with the additional rights part of the transfer value would receive all of the tax-free cash entitlement and the protected rights part of the transfer value would have no entitlement to tax-free cash. Basically, where benefits which are non-commutable are placed in one policy and commutable benefits are placed in another all the tax-free cash can be taken from the commutable benefits policy. This will change after A-Day. Subject to DWP confirmation, up to 25% of the transfer value can be taken as tax-free cash, this includes the protected rights part of the transfer value.

Example

Peter has a transfer value of £80,000, £10,000 of which is in respect of GMP benefits. The maximum amount of tax-free cash is £15,000. Peter is 59 and has just taken early retirement. He was not a regulated individual and he would like to take his lump sum benefit now to pay off the balance of his mortgage.

If the non-GMP benefits were transferred to a ‘s32’ buy-out and the GMP benefits converted to protected rights and invested in a personal pension plan, then 100% of the tax-free cash could be taken from the ‘s32’ buy-out immediately as Peter is over age 50. The balance of the fund in the ‘s32’ buy-out would then be paid as an annuity.

Before A-Day the protected rights benefits could not be taken under the personal pension plan until age 60. After A-Day, subject to DWP confirmation, protected rights benefits can be taken from age 50 until 2010. After 2010 the minimum age will increase to 55.

If the transfer is split:

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

£10,000 

£70,000

 then the tax-free cash will be split:  

PERSONAL PENSION PLAN

’S32’ BUY-OUT BOND

Nil from the personal pension plan as no tax-free cash sum can be taken from protected rights funds. After A-Day, subject to DWP requirements, up to 25% of protected rights funds can be taken as tax-free cash.

£15,000 from the 's32' buy-out. The tax-free cash can be increased by RPI from date of transfer (or leaving in the case of a transfer from a scheme in which the member is a deferred member) to retirement.

Other considerations

It is also possible for a transfer value to be split between: 

  •  more than one ‘s32’ buy-out*, 
  •  more than one personal pension, or
  • a ‘s32’ buy-out or a personal pension and a pension scheme of the new employer.

If part of the transfer value is made up of GMP benefits, then all of the GMP benefits must be paid into one policy, they cannot be split. The same applies to protected rights benefits.

* If a member has two or more ‘s32’ buy-out policies in respect of the same transfer, they all must come into payment at the same time. It is also possible for one ‘s32’ buy-out to be certified to provide 100% of the maximum lump sum where two separate buy-outs represent two concurrent schemes of the same employer for non-regulated individuals.

Her Majesty's Revenue & Customs (HMRC) have confirmed in their Update 147 (9 June 2004) that any transfers where tax-free cash entitlement is split un-proportionately in an attempt to gain more tax-free cash after A-day that this could be regarded as abuse of HMRC discretionary practice. Such abuse could result in tax penalties.

Summary - For regulated individuals when the transfer value is split between two plans the amount of the certified tax-free cash must always be split proportionately. For non-regulated individuals when the transfer value is split between two plans the maximum amount of tax-free cash that can be paid from the personal pension plan is 25% of the non-protected rights fund, assuming there is no nil certificate, and the maximum amount that can be paid from the ‘s32’ buy-out is split in proportion to the transfer value. After A-Day, subject to DWP confirmation, up to 25% of protected rights funds can be taken as tax-free cash.

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in regulation and practice. All references to taxation are based on our understanding of current tax law and practice and may be affected by future changes in legislation or by individual circumstances.

We cannot accept direct transfer business from members of the public. Transfers are complex and individuals should consult an Independent Financial Adviser for advice. Transfers depend on personal circumstances and may not always be in an individual's best interest. Production of a transfer value analysis is a necessary requirement of the transfer process.

Updated 6 July 2005

 

For professional advisers only