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Employer  >  Trustee Zone  >  OPS Matters  >  Relatively Beneficial Simplification of Tax-free Cash

Relatively Beneficial Simplification of Tax-free Cash

Don't fall off your seat, but we may soon see a real live actual piece of legislation that will  not only simplify pensions but may also give some scheme members more cash when they take their benefits.

It all centres around those members who have an entitlement to an amount of PCLS that's in excess of the current baseline 25% tax-free limit - commonly called 'tax-free cash protection'. You can find out more on tax-free cash protection here.

What happens now
As things stand, some members who have tax-free cash protection will have their PCLS calculated by taking the amount of tax-free cash on 5 April 2006 and increasing that in line with the lifetime allowance. But there is an extra amount that can be paid, depending on whether the member continued to participate in the scheme after 5 April 2006. In short, someone who remains an active member of the scheme has what's called 'relevant benefit accrual'. And someone who has 'relevant benefit accrual' can get an extra 25% cash, basically based on the increase in the value of the pension benefits from 5 April 2006 to the date the benefits are taken.

For example:

Tax-free cash at 5 April 2006  = £50,000
Value of benefits at 5 April 2006  = £100,000
Value of benefits when taken  = £140,000

If the member does have relevant benefit accrual:

PCLS available will be £50,000 increased with the lifetime allowance
plus
25% of £140,000 - (£100,000 increased in line with the lifetime allowance)

If the member doesn't have relevant benefit accrual:

PCLS available will be £50,000 increased with the lifetime allowance only.

The problem
Seems straightforward enough. And it is for DC schemes as relevant benefit accrual occurs basically when a contribution is paid to the scheme after 5 April 2006. But for DB schemes (and cash balance schemes), working out whether a member has relevant benefit accrual isn't so easy.

It's necessary to work out the value of the benefits and test this against 'the appropriate limit'.  And it's this limit that's been identified as being far too complicated. It's basically a test which looks at the increase in the value of the benefits compared with the higher of RPI increases and 'the earnings recalculation value'. The 'earnings recalculation value' uses the lesser of pensionable salary or 'the post commencement earnings limit'. The 'post commencement earnings limit' itself has two definitions, depending on whether the member was 'capped' - i.e. which regime they were in before A-Day. By now, I'm guessing you can see why this needs to be simplified.

The proposal
To make things easier, the proposal is to completely remove the requirement to have 'relevant benefit accrual' in order to get the extra 25% cash based on post A-Day growth. This will make it easier to work out the benefits and may also give some members more tax free cash than they would have got. A win-win situation. Here's what HMRC Pre-Budget Note 14 had to say on the subject:

When will the change happen?
All we've seen on this just now is the Pre-Budget report laying out a basic description and a recent e-mail from HMRC confirming our understanding which is set out above. But we do need to see the draft regulations before we can say for certain that this is how it will work. But it does look like this will simplify matters somewhat and possibly give some members more tax-free cash when they take their benefits.