Tax-Free Cash

Tax-free cash represents the single biggest tax break offered by pensions, so it is vital to make the best use of it.

From A Day, the tax-free cash entitlement will normally be fixed at 25% of fund value for most schemes. This has implications for members of pension schemes, primarily occupational, whose tax-free cash entitlement is currently higher, or lower, than 25%.

Protecting a Lump Sum

For members of occupational pension schemes, the maximum allowable tax-free lump sum at retirement can be calculated on various bases.

However, individuals with many years’ service and high final earnings are likely to exceed the 25% tax-free cash entitlement. In fact, it is possible the entire fund could be used to provide the tax-free lump sum.

The amount of tax-free cash that occupational pension scheme members will be entitled to, in respect of their service up to A Day, will be calculated as if they were leaving service on 5 April 2006. The maximum tax-free cash entitlement for service post A Day will be limited to a maximum of 25%.

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There are three potential planning opportunities:

Maximising final remuneration pre A Day may increase your tax-free cash entitlement.
If your occupational pension fund is currently less than the allowable tax-free cash sum, consider increasing contributions or making single contributions pre A Day. This would effectively go directly into boosting your available tax-free cash on retirement.
If your entitlement on 5 April 2006 is greater than 25% you should take steps to ensure it is protected within the scheme.

Protecting Occupational Pension Schemes

The occupational pension schemes trustees will need to change the pension scheme rules to ensure your tax-free cash entitlement is protected post A Day. Otherwise, you risk losing your entitlement to any tax-free cash in excess of 25%. If you transfer out of the scheme in future, then it is likely you will also lose this entitlement.

If the scheme relates to previous employment, even if the trustees change the scheme rules to protect the entitlement, you are likely to lose the protection if you move the pension to another scheme post A Day.

In this event, it may be worth considering moving your pension into a 'Section 32' policy before A Day to protect your entitlement. However, careful analysis is required to establish whether the benefits outweigh any costs and that the Section 32 policy chosen suits your needs. Taking independent financial advice is essential in these cases.

Two forms of protection are available and these are subject to the same rules and restrictions as those for the Lifetime Allowance.