Technical Insight
Maximising lifetime tax-free lump sums
Clearing up scheme specific tax-free cash and transitional tax-free amount certificates confusion.
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It has now been a year since the lifetime allowance was abolished. There are a number of changes where effective advice can really help clients increase the tax-free lump sums they can take.
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- Maximising tax-free lump sums with scheme specific tax-free cash
- When, and when not, to use a transitional tax-free amount certificate (TTFAC)
Maximising tax-free lump sums with scheme specific tax-free cash
Where a client holds uncrystallised rights in multiple pension schemes and at least one of those pensions includes scheme specific tax-free cash, the order those pensions are accessed can make a big difference to the total tax-free cash that can be paid.
Under the lifetime allowance (pre-6 April 2024) the guidance was usually to take scheme specific tax-free cash first and then take other benefits, this enabled clients to maximise their tax-free cash. Since the removal of the lifetime allowance this position has been reversed.
Under the new rules the LSA is reduced by 25% of the total pension value used to pay the scheme-specific tax-free cash and the LSDBA is reduced by the amount of the tax-free lump sum paid. However, there are a few important points to consider; with scheme specific tax-free cash:
- clients don’t need to have any available LSA, they are only required to have available LSDBA
- lump sums exceeding the LSA are still tax free up to the available LSDBA
- any excess above the LSDBA is subject to income tax at the client’s marginal rate
This means clients can take tax-free cash from their other pensions using up their LSA, then take scheme specific tax-free cash in excess of the LSA. This can make a big difference to how much tax-free cash can be paid.
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Planning tip
It is crucial to assess the benefits a clients pensions hold. The more a client can access tax-free, the less income tax they will face. Remember, in order to access scheme-specific tax-free cash then the benefits from the whole scheme need to be taken at the same time, so phased retirement is not an option from those schemes.
Case study
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Ismail has two pensions, one a personal pension and the second is an occupational scheme which includes scheme specific tax-free cash. He is an additional rate taxpayer and wants to maximise the tax-free cash from his pensions and is seeking advice.
- The personal pension is valued at £800,000.
- The occupational pension is also valued at £800,000, on 5 April 2006 it was valued at £400,000, with tax-free cash of £200,000 qualifying for scheme specific tax-free cash.
He hasn’t taken any other pension benefits and has an LSDBA of £1,073,100, and LSA of £268,275.
| Personal pension taken first | Occupational pension taken first |
|---|---|
| Step 1 | Step 1 |
| Personal Pension value £800,000 | Occupational value £800,000 |
| Tax-free cash of £200,000 | Formula provides tax-free cash of £368,460 |
| LSA is reduced from £268,275 to £68,275 | LSA is reduced by £200,000 (25% of value) |
| LSA reduced from £268,275 to £68,275 | |
| Step 2 | Step 2 |
| Occupational Pension value £800,000 | Personal Pension value £800,000 |
| Formula provides tax-free cash of £368,460 (not capped by LSA) |
Tax-free cash is capped to £68,275 |
| Total tax-free lump sum of £568,460 | Total tax-free lump sum of £436,735 |
| LSA reduced to £0 | LSA reduced to £0 |
| LSDBA reduced to £504,640 | LSBDA reduced to £636,365 |
As scheme specific tax-free cash can exceed the available LSA and is still tax-free up to the LSDBA, then taking the personal pension first allows Ismail to receive the full tax-free payments from both pensions. By changing the order the pensions are accessed, Ismail can take an additional £131,725 tax-free cash. As an additional rate taxpayer this will have saved £59,276 income tax, demonstrating the value of advice.
When, and when not, to use a transitional tax-free amount certificate (TTFAC)
A TTFAC provides an alternative way of calculating the value of benefits a client has taken under the lifetime allowance.
A TTFAC is only relevant in relation to pensions that were accessed before 6 April 2024.
One of the most important rules to remember is that a TTFAC is no longer available if a client has taken any tax-free lump sums since 6 April 2024 (apart from certain small pot lump sums).
Clients may not realise that accessing their other pensions may mean they can no longer maximise their tax-free cash using a TTFAC. Reviewing a client’s pension benefits early to see if they could benefit from a TTFAC could show a tangible value to your advice.
The clients that could benefit from a transitional tax-free amount certificate include those who:
- Were unable to access any tax-free lump sum due to underfunded GMP.
- Did not commute DB income for tax-free cash.
- Were entitled to guaranteed annuity rates (GARs) and maximised their income with no tax-free cash.
- Transferred benefits to a QROPS scheme.
- Are aged over 75 and have unused benefits that were tested as a BCE at age 75.
- Accessed their pensions between 6 April 2016 and 5 April 2020, when the lifetime allowance was lower than £1,073,100.
Samantha took pension benefits in August 2016 when the lifetime allowance was £1m. She used 100% of the lifetime allowance, taking £250,000 tax-free cash. Under the standard calculation she has used £268,275 (£1,073,100 x 100% x 25%) of her LSA, leaving no LSA for further benefits. A TTFAC would show she used £250,000 of her LSA, leaving her with an LSA of £18,275.
Pre commencement pensions and TTFAC
A common adviser query, has been how does a TTFAC work with pre commencement pensions (pensions put into payment before 6 April 2006). A TTFAC won’t provide any benefit in relation to any pre commencement pensions. There are two scenarios:
- A client with pre commencement pensions who has not had a BCE between 6 April 2006 and 5 April 2024 cannot apply for a TTFAC.
- A client who has had at least one BCE between 6 April 2006 and 5 April 2024 (including any age 75 BCE) will have had a deemed BCE for the pre commencement pension. These clients can apply for a TTFAC.
However, both the standard calculation and the TTFAC calculation assume that 25% of any pre commencement pensions were paid tax free, even where no tax-free cash was paid. The TTFAC differs to the standard approach only in relation to BCEs between 6 April 2006 and 5 April 2024, and not any deemed BCE.
When could a TTFAC leave your client worse off?
There are a few scenarios where a TTFAC may result in less tax-free cash being available than under the standard calculation, in particular where:
- Clients took tax-free cash when the lifetime allowance was higher than £1,073,100
- Clients have taken scheme-specific tax-free cash before 6 April 2024.
In both scenarios, clients may have taken more tax-free lump sums than the deduction to the LSA under the standard calculation. Lump sums from one pension will offset against other pensions where clients may have taken no tax-free cash.
As there are scenarios where clients could have a lower tax-free entitlement using a TTFAC your advice will be important. Below is a case study showing what this may look like.
Case study
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Nicola took scheme specific tax-free cash of £260,000 from a pension valued at £400,000 in 2022 using 37.27% of the LTA. She then took a scheme pension with no tax-free cash from a DB scheme in 2023 using 50% of her LTA. She has no transitional protection, so has a starting LSA of £268,275 and LSDBA of £1,073,100. She has a further uncrystallised pension valued at £200,000.
As Nicola took no tax-free cash when taking her DB pension she wants to know if she would benefit from a TTFAC.
Standard calculation
Using the standard calculation Nicola has used 87.27% of the LTA of £1,073,100, this provides a value of £936,494.37.
She has therefore used £234,123.59 (£936,494.37 x 25%) of her LSA as a result of pensions taken before 6 April 2024.
Her remaining LSA is £34,151.41 (£268,275 - £234,123.59).
The permitted maximum she can take from her remaining pension is the lower of:
- £50,000 (25% of £200,000)
- The remaining LSA of £34,151.41
TTFAC
If Nicola applied for a TTFAC then she has already taken £260,000 tax-free cash.
Her available LSA would be £8,275 (£268,275 - £260,000).
The permitted maximum she can take from her remaining pension is the lower of:
- £50,000 (25% of £200,000)
- The remaining LSA of £8,275
In this scenario applying for a TTFAC would result in less tax-free cash being available.
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