Protect your tax free pension cash entitlement

Pension simplification which comes into force in April 2006 will allow many people in company pension schemes to take more tax free cash than is currently possible. But others will find that their tax free cash entitlement will actually fall as a result of the new rules after A Day - the date when the new pension rules take effect.

So anyone in this position needs to take action to ensure that their current tax free cash entitlement is protected after A Day. There are various ways of doing this if you are a higher earner whose fund value is more than £1.5m and whose tax free cash exceeds £375,000 (25% of the lifetime allowance of £1.5m), there will be special arrangements for them to do so.

One of these is called Primary Protection which allows your tax free cash entitlement at A Day to be indexed in line with the annual increase in the lifetime allowance up to the date when you take your benefits. In addition, you will also be able to take 25% of the fund you have built up after A Day as a tax free sum.

For instance, the Lifetime Allowance will increase from £1.5m in 2006-07, to £1.6m in 2007-08, £1.65m in 2008-09, £1.75m in 2009-10 and £1.8m in 2010-11.

Alternatively, higher earners may wish to opt for Enhanced Protection which involves your tax free cash entitlement at A Day being expressed as a percentage of your funds value at A Day. It is this percentage that is then used to calculate the tax free lump sum when you take your pension.

Special Protection on offer for smaller pension pots

But there is a third route called Special Protection for those whose tax free cash does not exceed £375,000 (and who are therefore not eligible for either primary or enhanced protection), but whose entitlement to tax free cash is greater than 25% of their pension fund at A Day.

If you want Special Protection you do not have to register your fund with the Inland Revenue (as with Primary and Enhanced Protection), but you need to check that your scheme administrators keep sufficient records to prove that you were entitled to more than 25% tax free cash just prior to A Day.

Under Special Protection, the tax free cash entitlement is indexed in line with the Lifetime Allowance up to the date when the pension is taken. In addition, a tax free lump sum of 25% can be paid to reflect contributions made after A Day.

But if you take Special Protection you need to remember that tax free cash protection is lost if you transfer your benefits to another pension scheme, unless this takes place as part of a bulk transfer.

The latter refers to where your pension is moved to another pension arrangement, along with that of other members of the same scheme. Protecting tax free cash is clearly a complex area and anyone who thinks they might be affected should seek independent financial advice.

Scheme trustees are not allowed to give financial advice to scheme members, although they can give you information to help you make a decision. Furthermore, if you are considering transferring benefits from a final salary scheme, the adviser must be G60 qualified.

Elisabeth Gibling of Chase de Vere Private Clients comments, With Primary and Enhanced Protection, the protected tax-free amount is maintained even if you decide to transfer to an alternative pension arrangement. This provides maximum flexibility if you find that the current pension arrangement no longer meets your needs.

23 May 2005 © Moneyextra.com

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