Unexpected increase to tax-free cash allowance
Good news for some occupational pension scheme members
In amongst the technical papers issued by HM Revenue & Customs (HMRC) on the back of the Budget 2012 changes, Skandia has discovered a hidden gem. An alteration in the formula for calculating tax-free cash for pre 6 April 2006 (A-Day) members of occupational pension schemes could lead to people receiving more tax-free cash when they retire.
Occupational pension scheme legislation
Prior to A-Day, occupational pension scheme legislation determined the level of tax free cash available to members of such schemes. Since A-Day, the level of tax-free cash has been set at a maximum of 25 per cent.
Pre A-Day members of occupational pension schemes have been allowed, under HMRC rules, to protect the tax-free cash rights they held at A-Day that were greater than 25 per cent. In such cases the tax-free cash entitlement can further increase over time, based on two calculations introduced by HMRC:
1. The A-Day protected tax free cash entitlement is automatically increased by the increase in the Lifetime Allowance up to 6 April 2012, an increase of 20 per cent. All members with protected tax-free cash receive this uplift regardless of how well their occupational scheme investment has done since A-Day.
2. The tax-free cash entitlement is further increased by 25 per cent of any positive growth in the value of the pension fund since A-day.
Discounted investment growth
Prior to 6 April 2012, the level of investment growth was discounted by 20 per cent of the pre A-day fund value to take account of the increase in Lifetime Allowance from £1.5m to £1.8m up to 6 April 2012. From 6 April 2012, this discount no longer applies, resulting in a higher tax-free cash allowance for many people, provided they have seen positive investment performance since April 2006.
Good news for many people
This is really good news for many people who have a protected tax-free cash entitlement in an occupational pension scheme they joined prior to 6 April 2006. The new calculation can greatly enhance the amount of tax-free cash these people can take at retirement.
Many people may not know whether they have a protected cash entitlement from their service up to A-Day in these schemes, so it is essential to check with those schemes to establish what their tax-free cash entitlement was at A-Day.
Please note: this improvement does not apply for those who have applied for fixed protection. Their revaluation of A-Day cash is still on the pre 6 April 2012 basis which subtracts the A-Day fund value increased by 20 per cent from the current fund value to determine whether there is any additional tax free cash entitlement.