Tech talk

Transfers Post A-day - TT22/06

The new rules introduced on the 6th April this year were intended to make understanding pensions easier by replacing eight regimes with one. However, as we can see from what follows there are new issues that have to be considered when dealing with pension transfers.

Where the new regime is not as beneficial as the old regimes protection is available so that the pension rights accrued under the old regimes would not be disadvantaged. In particular it was possible to build up tax free cash in excess of 25% of the fund and also establish pension schemes with a retirement age of less than 50 for people in certain occupations recognised by the Revenue. A transfer could result in loss of transitional protection and we consider this under the section Transfers and Transitional Protection.

There is another area of transitional protection where pension fund monies of significant value that have been acquired in the old regimes could be liable to a lifetime allowance charge on benefits being paid in the new regime. Transitional protection is available in the form of primary and/or enhanced protection. A transfer could create the loss of enhanced protection and we look at this in more detail in the section Transfers and Enhanced Protection.

The question of defined benefit transfers and the annual allowance was the subject of TechTalk 21.

Transfers & Transitional Protection

Where a client has pension rights built up under the old regimes that entitle the member to tax free cash of more than 25% of the fund and/or to take benefits from an age of less than 50 then these rights will be protected under the new regime. This is provided that the pension monies remain in the existing arrangement, or, if transferred, that the transfer meets certain conditions.

Ignoring primary and enhanced protection, the tax free cash will be increased in line with the movement in the standard lifetime allowance. There is a requirement that all of the tax free cash must be taken from the scheme at once i.e. it is not possible to phase the tax free cash. The requirement to take all of the benefits from the scheme at once also applies to taking benefits from a scheme with a low retirement age.

If a transfer takes place after 'A-day' the protection is lost and the tax free cash will default to the lower of 25% of the fund or 25% of the standard lifetime allowance, and the earliest that benefits can be taken is age 50 up to and including 5th April 2010, thereafter age 55.

However the protection can be maintained if the transfer is part of a block transfer or if the transfer is a result of a scheme wind up.

There are certain conditions that must be met for a transfer to be part of a block transfer:

• More than one member transfers from the scheme at the same time.
• The transfers are made to the same scheme at the same time.
• Any members transferring that are looking to protect their tax free cash and/or early retirement age should not have been a member of the receiving scheme for more than 1 year.

If the member is the sole member of a scheme and winding up the scheme is not an option, then a block transfer could be available if a new member joins the scheme and transfers out with the original scheme member. Remember that this is possible under the new regime as there are no restrictions as to the type(s) of scheme(s) that individuals can join. The new member could be the spouse of the original member. Care would need to be taken with regards to minimum values, especially for the receiving scheme.

The second condition prevents block transfers being made to section 32 policies as these schemes can only have one member per scheme. A transfer to a personal pension scheme would satisfy this condition.

Care needs to be taken with the third condition. Some providers of SIPP schemes have used other companies' SIPP schemes and marketed the scheme as one of their own, whereas in reality it is two providers using the same scheme. For example life company A and life company B both badge the SIPP scheme of provider C, and market it under their own names. Assume a client is involved in a block transfer from his employer's CIMP scheme and that transfer is going to life company A's scheme. If that client has also had benefits in life company B's scheme for more than one year then the block transfer test will be failed, because life company B's scheme is exactly the same scheme as life company A's.

There are also conditions that require to be met to protect pre 'A-day' rights where benefits are being transferred to buy-outs on the wind up of a scheme:

• The trustees must purchase a single policy buy-out. Note that assignment of a policy out of a scheme does not qualify, nor do transfers to clustered buy-outs.
• The scheme that the wind up transfer is being made from was in force before 6th April 2006 and was deemed to be registered on 6th April 2006.
• The single policy buy-out must not be an immediate vesting contract.

Transfers & Enhanced Protection

Enhanced protection provides the client with immunity from the lifetime allowance charge and the annual allowance charge. However this protection could be lost on transfer.

Protection will be retained if the transfer is a permissible transfer. The following conditions must be met for the transfer to qualify as a permissible transfer:

• All of the benefits under the scheme are transferred.
• Normally all of the benefits must be transferred to one scheme, although they can be transferred to a number of arrangements within one scheme.
• A transfer from a defined benefit scheme to a defined benefit scheme is not a permissible transfer unless the transfer is as a result of one of the schemes winding up and both schemes are in respect of the same employment.
• The value of a defined benefit transfer to a money purchase arrangement must be calculated on an actuarial basis.

A transfer as a result of a pensions sharing order will not invalidate enhanced protection. Under point 8, the legislation states that the transfer must be made to one scheme, however the Revenue have verbally confirmed to us that, in certain circumstances, a transfer may be split and paid to more than one receiving scheme. For example if a defined benefits scheme transferred the GMP liability to a personal pension thereby converting this benefit to protected rights and the remaining transfer monies were transferred to another scheme then this would not be in breach of this condition.

The following list contains examples of transfers that are not permissible and would result in the loss of enhanced protection:

• A transfer from a money purchase scheme to a defined benefit scheme.
• A transfer from a defined benefit scheme to another defined benefit scheme where the two scheme are for different employers, or, if they are for the same employer, the transferring scheme is not winding up.
• A partial transfer from a scheme.

Where a client has benefits under a defined benefit scheme and has applied for enhanced protection the test as to whether there has been a 'relevant benefit accrual' that would invalidate enhanced protection is done at the relevant output time. In the case of a transfer this is the date on which the transfer is made.

To determine whether there has been a 'relevant benefit accrual' the 'appropriate limit' is compared against the transfer value. If the transfer value exceeds the 'appropriate limit' then enhanced protection is lost. If the transfer value does not exceed the 'appropriate limit' then enhanced protection is retained.

The 'appropriate limit' is calculated as the higher of the 'indexed amount' or the 'earnings recalculated amount'.

The 'indexed amount' is the value of the pension rights as at 5th April 2006 using a valuation factor of 20:1 increased by the greater of 5% pa, or RPI. If there are any contracted out rights then that element will increase by the relevant revaluation rate.

The 'earnings recalculated amount' is the pension accrual accumulated at 5th April 2006 applied to the earnings at retirement. There are rules that determine the maximum earnings that can be used.

For members who left the scheme prior to 6th April 2006 then the 'indexed amount' is the only calculation available to determine the appropriate limit.

The following example may help demonstrate the application of these rules.

Example

Client has 20 years service in a final salary scheme as at 5th April 2006. The accrual rate is 1/60th throughout and the salary at 'A-day' was £240,000.

Client registers for enhanced protection, and remains in the pension scheme for a further 5 years. The salary at leaving is £252,000.

The indexed amount is:
20/60 x £240,000 = £80,000 pa
Lifetime allowance value 20 x £80,000 = £1,600,000
Increase by 5% per annum over 5 years = £2,042,040

The earnings recalculated amount is:
20/60 x £252,000 = £84,000
Lifetime allowance value 20 x £84,000 = £1,680,000

Therefore the appropriate limit is £2,042,040.

If the transfer value exceeds £2,042,040 then relevant benefits accrual has occurred and enhanced protection is lost. Losing protection would result in the benefits being tested against the lifetime allowance. There would also be a test for the annual allowance.

Whilst the new pensions simplification regime has removed some of the issues surrounding transfers prior to 'A-day' e.g. whether to transfer to S32 or PP, they have created new issues that could result in an income tax liability for scheme members who transfer, or cause loss of enhanced protection by, for example, transferring defined benefits from a previous employer to the new employer's defined benefit scheme, or result in a reduction in the member's tax free cash entitlement.

Fraser Grant - June 2006