Guidance note on the operation of the taxation of Pension Schemes

(Transitional Provisions)(Amendment) Order 2006

1. This Order amends the legislation where a stand-alone lump sum is paid. The original order has had to be amended to ensure that the rules for a stand-alone lump sum fit more easily with those for protected pension commencement lump sums. There has been no change though in the basic underlying principle as set out in the original order and this will not affect the way such lump sums are paid in normal circumstances.

Background

2. From 6 April 2006 a pension scheme member can have a tax-free lump sum of up to 25% of the value of the pension benefits coming into payment. This is subject to the total lump sums the member has received being no more than 25% of the standard lifetime allowance. (The standard lifetime allowance for the 2006/07 tax year is £1.5 million so total lump sums cannot be more than £375,000 in that tax year.)

3. Before 6 April 2006 some pension scheme members had the right to either

• total lump sums of more than £375,000 or
• a lump sum of more than 25% of the value of their rights under the scheme.

4. The tax legislation provides protection for lump sum rights built up before 6 April 2006 in three forms.

A. Lump sum rights of more than £375,000 and the member has primary protection. (Guidance on how this protection works can be found in the Registered Pension Schemes Manual at RPSM03105135)
B. Lump sum rights of more than £375,000 and the member has enhanced protection (Guidance on how this protection works can be found in the Registered Pension Schemes Manual at RPSM03105185)
C. Neither of the above 2 forms of lump sum protection applies and in any pension scheme the member has the right to a lump sum of more than 25% of the value of their total rights under that scheme. (Guidance on how this protection works can be found in the Registered Pension Schemes Manual at RPSM03105500). This is known as ‘scheme specific’ lump sum protection.

5. Before 6 April 2006 some individuals with lump sum had the right to have all their scheme benefits paid as a tax free lump sum. Where an individual has the right to one of the forms of lump sum protection described above, and certain conditions are met, schemes may continue to pay all a member’s scheme benefits as a tax free lump sum. This kind of payment is called a stand-alone lump sum.

Conditions that need to be met to qualify for the payment of a stand-alone lump sum

General conditions

6. These conditions must be met before a stand-alone lump sum can be paid whatever form of lump sum protection the individual has

7. Like the normal tax free lump sum paid on ‘retirement’ (a pension commencement lump sum) a stand-alone lump sum cannot be paid before the member reaches the normal minimum pension age of 55 (50 until 5 April 2010) unless the member is ‘retiring’ on ill-health grounds. If a member has a protected pension age below the normal minimum pension age a stand-alone lump sum can be paid once the member reaches their protected pension age under the scheme.

8. A stand-alone lump sum cannot be paid once the member has reached age 75.

9. All of the member’s uncrystallised rights (benefits not yet in payment) under the scheme must be paid as a stand-alone lump sum. So you cannot leave any uncrystallised rights in the scheme and no other form of benefit can be paid at the same time.

10. In addition to the general payment conditions extra conditions will apply if the individual has

• protection of lump sum rights of more than £375,000 with enhanced protection, or
• scheme specific protection of lump sums of more than 25%.

Extra conditions where the individual has protection of lump sums of more than £375,000 with enhanced protection

11. The member has valid enhanced protection.

12. On 5 April 2006 the rights under all of the pension schemes the individual was a member of could have been paid out as a tax free lump sum without giving grounds for withdrawal of scheme approval. In making this test it is assumed that the member has left employment and that they are old enough to receive benefits.

Extra conditions where the individual has scheme specific lump sum protection

13. The member must take all the benefits (that were not already in payment before 6 April 2006) under the scheme at the same time. So it is not possible to take one tranche of benefits from the scheme and then take a second tranche as a stand-alone lump sum.

14. On 5 April 2006 the rights under all of the pension schemes relating to the same employment that the individual was a member of could have been paid out as a tax free lump sum without giving ground for withdrawal of scheme approval. In making this test it is assumed that the member has left employment and that they are old enough to receive benefits.

15. There has been no relevant benefit accrual under the scheme. The test for relevant benefit accrual here is the same test for relevant benefit accrual as is used for enhanced protection. RPSM03104500 explains what relevant benefit accrual is and when it occurs.

16. The benefits are paid either from

• a scheme that the individual was a member of on 5 April 2006, or
• a scheme that receives a transfer from such a scheme (see paragraph 20 below for the conditions that apply to this).

Amount of stand-alone lump sum

Lump sum paid under protection of lump sums of more than £375,000 with primary protection

17. Where someone has protection of lump sums of more than £375,000 with primary protection there amount of stand-alone lump sum that can be paid is limited by the formula

VULSR - APCLS

Where
VULSR = the value of the individual’s uncrystallised lump sum rights on 5 April 2006 (this value increased in line with the increase in the standard lifetime allowance)
APCLS = the value of any pension commencement lump sum and/or stand-alone lump sum that has previously been paid to the member (increased in line with the increase of the standard lifetime allowance).

18. Similarly where a pension commencement lump sum is paid under protection of lump sums of more than £375,000 with primary protection the amount of any stand-alone lump sum previously paid must be included when calculating the maximum allowable lump sum.

19. So the stand-alone lump sum cannot be more than the amount of the protected pension commencement lump sum.

Lump sum paid under scheme specific protection or protection of lump sums of more than £375,000 with enhanced protection

20. Where the individual has

• protection of lump sum rights of more than £375,000 with enhanced protection, or
• scheme specific protection of lump sums of more than 25%

and there has been no relevant benefit accrual the amount of stand-alone lump sum is not limited to the value of the lump sum rights as at 5 April 2006 indexed in line with the increase of the standard lifetime allowance.

21. Money purchase arrangements can pay a stand-alone lump sum which includes the full investment return on the value of the lump sum rights as at 5 April 2006 even though this is more than the 5 April 2006 value indexed in line with the standard lifetime allowance.

22. Defined benefits or cash balance arrangements can pay a stand-alone lump sum up to the amount of the appropriate limit. (RPSM03104525 explains what the appropriate limit is.)

Loss of the right to a stand-alone lump sum due to a transfer

Transfers into a scheme

23. Where the individual has protection of lump sums of more than £375,000 with primary protection the right to a stand-alone lump sum will not be lost due to the transfer of pension rights between pension schemes. This is because the rules relating to this protection apply an overall limit covering all a persons pension schemes rather than on a scheme by scheme basis.

24. Where the individual has

• protection of lump sum rights of more than £375,000 with enhanced protection, or
• scheme specific protection of lump sums of more than 25%

the right to the payment of a stand-alone lump sum will be lost where a scheme that has protection receives a transfer from another pension scheme unless certain conditions are met. This is to prevent artificial increases in lump sum protection through transfers.

25. The receipt of a transfer will not trigger loss of the right to a stand-alone lump sum where

• the transfer comes from a scheme where immediately before the transfer the member had the right to the payment of a stand-alone lump sum, and
• all of the member’s uncrystallised rights are transferred from the transferring scheme to the receiving scheme.

Transfers out of a scheme

26. Where a member has the right to a stand-alone lump sum due to scheme specific lump sum protection benefits the right to a stand-alone lump sum will be retained where

• a transfer is made from a scheme where the member has a right to a stand-alone lump sum to another scheme that the individual is not already a member of, and
• the transfer is a block transfer (see RPSM03105521 for guidance on what is a block transfer).
• The receiving scheme does not hold any funds relating to that member.

27. These rules broadly replicate the transfer rules applying to all scheme specific lump sum protection with the addition of the condition that the transfer does not relate to a member of a transferee scheme which is to prevent abuse of the rules.

28. There are no additional restrictions on transfers out of a scheme where a member has a right to a stand-alone lump sum by virtue of claiming enhanced or primary protection where lump sum rights on 5 April 2006 exceeded £375,000.

29. For the avoidance of doubt the purchase of a deferred annuity contract on the winding up of a scheme in accordance with articles 13 – 16 The Pension Schemes (Transfers, Reorganisations and Winding-up)(Transitional Provisions) Order – SI 2006/573 will be a block transfer – see RPSM03106072. As a result, subject to all the other conditions being met the deferred annuity contract may pay a stand-alone lump sum.