Case study: transitional certificates and pre-2006 benefits

The case:

In 2005, Bill retired from his employer, deciding against taking a tax-free cash lump sum and instead only taking his defined benefit pension of £18,500 a year.

He then started work for another company, and in the subsequent 10 years built up a SIPP. In 2015 he took 25% of his £375,000 SIPP pot (£93,750) as tax-free cash and moved the remainder into drawdown. Thanks to regular increases, his defined benefit pension was then worth £30,000 a year.

He had used up 90% of his lifetime allowance. However, he has another SIPP of £150,000 he has not yet touched and would like to take his full 25% – £37,500 – from it.

Bill has heard that if he has not taken his full tax-free cash entitlement from previous pension schemes, there may be an opportunity to apply for a transitional tax-free amount certificate (TTFAC) which could boost his lump sum allowance (LSA). This might mean he can take his full tax-free cash allowance from his untouched SIPP.

The prescription:

Bill’s financial adviser, Ted, explains the rules around transitional certificates are very complicated and great care needs to be taken. If the transitional certificate gives a worse outcome than using the standard transitional calculation, the applicant still has to use the certificate – they can’t choose to ignore it.

He first checks that Bill hasn’t taken any pension benefits since 6 April 2024. If he had, it would not be possible to apply for a certificate.

Ted explains the best way to decide whether to apply for a transitional certificate is to compare the outcome from using it against relying on the standard transitional calculation.

But first he wants to explain what happened in 2015 when Bill crystallised his SIPP, and how the percentage of lifetime allowance used was worked out.

Broadly, pre A-Day pensions in payment were treated as if they crystallised immediately before the first benefit crystallisation event (BCE) on or after 6 April 2006. The pension in payment is converted to a lump sum, but a factor of 25 is used instead of 20 to reflect that tax-free cash was probably taken. In Bill’s case his pre-2006 pension was deemed to have used up:

25 x £30,000 = £750,000 / £1,250,000 = 60% of the lifetime allowance.

Bill used up another 30% (£375,000 / £1,250,000) when taking his SIPP benefits. Making a total of 90% of the lifetime allowance used.

Moving back to the current day, under the standard transitional calculation, Bill’s remaining LSA is worked out by deducting 25% of the lifetime allowance he has used up:

£268,275 - (25% x 90% x £1,073,100) = £268,275 - £241,448 = £26,828

No adjustment is made for the benefits he took before 2006, as these ‘pre-commencement benefits’ were already taken into account in 2015.

Ted then goes on to explain if a member applies for a transitional certificate, instead of using the standard transitional calculation, the actual amount of tax-free cash taken is deducted from the LSA. That’s why, if the member took less than the full tax-free cash entitlement, a certificate could possibly give a higher available LSA.

But then Ted breaks the bad news to Bill. That rule only applies to benefit crystallisation events – in other words events that used up lifetime allowance during the period 2006 to 2024. If someone took benefits before 2006 then the standard formula (25 times the annual pension in payment when the first BCE occurs) is still used to convert that element into a capital sum, and it’s always assumed 25% of that amount was taken as tax-free cash.

So, the transitional certificate would give a remaining LSA of:

£268,275 - £93,750 - (25% x 25 x £30,000) = -£12,975

As this is a negative figure the remaining LSA would be nil. Bill would be worse off if he applies for a transitional certificate.