Are you entitled to more than 25% of your tax-free cash?

October 7th, 2014

A recent article from the Telegraph provided some insight into the possibility of accessing more of your tax-free cash than you first thought.

“For retirees who have worked hard to build up a handsome pension pot, being taxed on their retirement income feels like a kick in the teeth. But thanks to a little-known quirk relating to pensions set up before 2006, hundreds of thousands of savers could boost the tax-free cash they can take from company pensions before this date from 25pc, to as much as 100pc.

Even better news is that the new pension freedoms coming in April 2015 will allow people to spend their taxable pension as, and when, they choose. And after the Budget in March, the Government popped a cherry on top of these pensions, which unlike final salary schemes are linked to the performance of the stock market, by introducing rules that allow people to enjoy bumper sized tax-free lump sums at the same time as enjoying the pensions freedoms.

But people who want to enjoy this double pension bonanza will either have to be prepared to do their homework, or pay a financial adviser to help them. Because many of these contracts, which were written before the Government tightened up tax rules in 2006, require people to buy an annuity with the rest of the money.

Until recently, transferring funds with a protected level of tax-free cash to another pension company, to get out of buying an annuity, would have caused any extra tax-free cash entitlement to be lost.

But earlier this year, HM Revenue & Customs introduced new rules to allow savers transferring their funds to hang on to their bigger tax-free lump sums, on the condition that they transfer the funds before 6 April, and take their lump sum before 6 October 2015.

Around 275,000 people in the UK have pensions which would let them take a tax-free lump sum higher than 25pc of their fund, if they choose to, according to insurer Aviva. But the government-imposed time limit may cause anger among workers below the age of 55 on 6 October 2015, as they will miss out on the right to any pre-2006 protected lump-sums because they will be too young to access their pension without incurring a nasty 55pc tax bill.

The protections mean some people can take as much as 100pc of their fund as cash, while others will be entitled to as little as a 1pc boost, giving them 26pc of their pension tax-free, although the average uplift is 10pc, giving 35pc tax-free cash. A formula is used to calculate this relates to your wages when you left and years of service.

When Douglas Cruikshank, 63, was made redundant from his IT project management job earlier this year, the discovery that he could take 75pc of one of his pension pots as a tax-free lump sum felt like a gift from above.

With no regular income to live off, he sought financial advice in order to turn the various pension pots he had accumulated since starting work aged 19, into retirement income.

Of the five pots that made up his £200,000 pension, Mr Cruikshank, who lives in Oval, South London, was elated to discover he could take bumper tax-free lump sums from two of them. He took his tax-free lump sum immediately and used the money to maintain the comfortable lifestyle he’s used to. Despite being unemployed and without a state pension as he is too young to collect it, the extra money means he is still enjoying regular trips to his holiday home in Cyprus, and treating his 10 grandchildren to days out to their favourite spot in Eastbourne – luxuries he says the additional tax-free money has helped him to afford.

Savers whose pension investments have performed poorly are likely to receive the most tax-free cash because pension firms calculate its size with a formula that uses a pre-decided interest rate, the size of the fund, and the savers’ final salary. Savers get more tax-free cash if the said interest rate outstrips the funds’ annual returns.

Because the quirk only relates to pre-2006 pension plans, savers are likely to have since found work elsewhere and left their pensions behind them. But because pension firms require proof of their final salary, people may have a job on their hands finding data that dates back decades, before electronic records existed.

Protected pension lump sums: Your safety checklist

Fidelity’s Retirement Director, Alan Higham, walks you through the things you need to watch out for when trying to get a protected pension lump sum and pension freedoms at the same time:

• Check there aren’t other implications of making the transfer that outweigh the benefits. For example, it could it trigger a penalty on with-profits investments or there may be guaranteed annuity rates which make the annuity option very valuable.

• Taking the cash lump sum will change the inheritance tax position on the pension should the client die before age 75. Currently, it has no tax due on death but afterwards, the tax free cash forms part of the estate and any lump sum distribution of the rest of the pension fund is taxed at 55pc. An income can be paid to a partner with tax paid at their normal income tax rate.

• Some providers changed their legacy contracts in 2006 to allow the protected tax free lump sum to be taken from the old plan before transferring the balance to a new contract internally to access flexibility. Clients with this option don’t have to transfer before April or take benefits by October. They can take their lump sum then move to a flexible income vehicle, whenever it suits them.

• If you don’t have records of the salary you were earning when you left the company with which the pension was associated, get in touch with HMRC as they may have records of your tax bill for that year, which you could use as evidence to present to your insurer.”

To find out more, please click here to visit it the telegraph article.