Be careful what you apply for

The case:

Cathy took her defined benefit pension in August 2014.

She took a scheme pension of £46,500, which was valued as using up 62% of the £1.5 million lifetime allowance at the time. She also took a cash lump sum of £270,000, which used up another 18%, making a total of 80% of the lifetime allowance used.

Cathy has a SIPP, which she has not yet crystallised, worth £250,000.

Cathy wants to take her pension commencement lump sum (PCLS) from her SIPP to fund some house improvements and wants to know the maximum she can take.

The prescription:

Cathy’s financial adviser tells her the pension tax rules are changing in a few weeks’ time. From 6 April 2024, the lifetime allowance will be abolished, and will be placed by two new allowances. The lump sum allowance will test the amount of tax-free lump sums Cathy will receive in life. And the lump sum and death benefit allowance will limit her tax-free lump sums taken in life as well as those her beneficiaries will receive when she dies.

Most people will have a lump sum allowance of £268,275. (But this could be higher if they hold lifetime allowance protection.) If someone has already taken some of their pension benefits before 6 April 2024 then the lump sum allowance will be reduced to take account of this. Generally, it will be reduced by 25% of the amount of the current lifetime allowance already used up.

So, for Cathy the standard transitional calculation reduces her lump sum allowance to:

£268,275 – (25% x 80% x £1,073,100) = £53,655

This standard calculation always assumes someone took 25% cash. However, Cathy did not take 25% of her defined benefit pension as cash; she took a lower amount. Her financial adviser knows it’s possible for those people who took less than 25% tax-free cash from previous crystallisations to apply for a ‘transitional tax-free amount certificate’ to hopefully boost their lump sum allowance, and they wonder if that would be appropriate for Cathy.

The certificate details the monetary amount of tax-free lump sums paid out to pension savers before 6 April 2024. Cathy could apply for the certificate from any pension scheme she is a member of, and if she gives them complete evidence of the tax-free lump sums already taken, they have to grant her a certificate within three months or explain why they will not provide one.

Once she has the certificate, she would have to give it to the scheme organising her first crystallisation after 6 April 2024. They will recalculate the lump sum allowance, as well as the lump sum and death benefit allowance, using the information on the certificate (instead of relying on the standard transitional calculation).

If Cathy asks her pension scheme for a certificate it would show the tax-free lump sums taken as £270,000.

But if this figure is then deducted from her lump sum allowance it would give a negative number:

£268,275 - £270,000 = negative number

Relying on a certificate would wipe out her whole lump sum allowance, meaning she would not be able to take any further PCLS from her SIPP. Cathy and her adviser decide not to ask for a certificate, and instead to use the standard reduced lump sum allowance of £53,655.

But it’s a good thing they did the calculations before applying. If Cathy had applied, the scheme would have had to grant her a certificate as she had given them complete evidence of tax-free lump sums already taken.

Once someone applies for a certificate, it’s an irreversible decision. Cathy would then have to use the certificate in future crystallisations, meaning she would not be able to take any PCLS from her SIPP. Instead, she would have to pay tax on all withdrawals.