Protected tax-free cash in the new pensions' regime

A few years ago, the UK’s fiscal event schedule was geared around a Spring Statement and an Autumn Budget.

This made sense. After all, the intention of the Budget is to announce new tax measures, and time has to be given to put them into practice for the start of the new tax year.

However, it now appears this careful timetable has been thrown out of the window. Over the past year we have had a Spring Statement in March 2022, a ‘mini-Budget’ in September, an Autumn Statement in November, and then we had a Spring Budget in March.

The ‘rabbit out of the hat’ for the Spring Budget was the abolishment of the lifetime allowance, starting with the removal of the lifetime allowance tax charge next year, and the restriction of tax-free cash to £268,275 for those who don’t already have protection.

HMRC and the industry has had only three weeks to incorporate these new rules. So, it’s understandable why both are frantically trying to nail down exactly how the new pensions tax regime will work in 2023-24.

This article discusses a key area where we have recently got more information – how protected tax-free cash will work in the new regime.

The new pension tax rules

The lifetime allowance charge will be removed from 6 April 2023, with the intention that the lifetime allowance itself be abolished from April 2024. However, the amount of tax-free cash an individual can take over their lifetime will be kept frozen at the current level of £268,275 (25% of today’s standard lifetime allowance of £1,073,100).

Because a framework will be needed to monitor how much tax-free cash is taken, pension schemes still have to carry out tests at benefit crystallisation events (BCEs). This includes asking members for information on how much lifetime allowance they have previously used up and giving them the details of how much lifetime allowance they used on this occasion. This may seem nonsensical to pension scheme members, but for the time being it remains an important part of the pension tax framework.

Other immediate changes are the rise in the annual allowance to £60,000, as well as the increase in the money purchase annual allowance (MPAA) to £10,000 (for all those who have ever triggered the MPAA), and a new minimum tapered annual allowance of £10,000.

Protected tax-free cash

One important announcement on Budget Day was, despite the restriction of tax-free cash to £268,275, that if an individual had previously protected a higher amount of tax-free cash, they would get to keep this higher entitlement.

And in a generous addition, HMRC also confirmed that those who already hold enhanced or fixed protection would be able to re-start building up their pension from 6 April 2023, without losing their protected tax-free cash entitlement.

Enhanced protection

Enhanced protection was one of the original forms of lifetime allowance protection offered following A-day’s introduction of pension simplification rules. Anyone could, after 5 April 2006, apply for enhanced protection. If they did then they would never face a lifetime allowance tax charge, regardless of the final value of their pension, but in return they couldn’t have any further ‘relevant benefit accrual’ in the pension scheme through contributions or building up benefits in a defined benefits scheme.

Individuals didn’t have to have over £1.5 million in their pension fund to apply for enhanced protection. So it suited those who could just easily stop contributing and allow investment growth to propel their pension fund upwards.

If the member had a tax-free cash entitlement of over £375,000 on 5 April 2006, then their protection certificate included the percentage of their fund they could take as tax-free cash. This percentage could be more or less than 25%.

HMRC has now confirmed the maximum amount of tax-free cash these members will be able to take will be the lower of:

This makes sense. Otherwise, as it’s calculated as a percentage of the final fund, once the member re-starts contributions their tax-free cash entitlement would go shooting up in value. And that would go against the spirit of the new regime.

Below is an example of how it works:

Edward applied for enhanced protection in 2007. His pension fund on 5 April 2006 was £1,400,000, and his protection certificate showed he could take 40% of his fund as tax-free cash.

On 5 April 2023, his fund is now worth £2 million. He is still working and a few days later chooses to pay in a pension contribution of £100,000 using carry forward. In March 2024, his pension fund is £2.2 million.

The amount he can take as tax-free cash is £800,000 (40% of £2 million).

However, if Edward’s fund had fallen in value so it was worth £1.8 million in March 2024, then the amount he can take as tax-free cash is the lower amount, £720,000 (40% of £1.8 million).

If, on applying for enhanced protection, the member’s tax-free cash entitlement was less than £375,000, then there wouldn’t be a specific PCLS percentage on the protection certificate.

For these members their tax-free cash is calculated as the lower of:

This rule carries on into the new tax year.

Kali applied for enhanced protection in 2008. Her pension fund on 5 April 2006 was £1,200,000, and her tax-free cash entitlement was 25% of the fund, £240,000. As this is less than £375,000, she did not protect her tax-free cash when applying for enhanced protection.

In August 2023, she decides to pay £50,000 into her pension. She keeps her enhanced protection. A year later, in August 2024, her pension fund is worth £2 million.

Her tax-free cash is worked out as £375,000. It is based on a £1.5 million lifetime allowance (as that is lower than her fund of £2 million).

So even though she did not protect her tax-free cash when applying for enhanced protection she still is entitled to a higher tax-free cash amount than the new fixed level of £268,275.

Fixed protection

As the lifetime allowance tumbled in value during the 2010s, there were three different opportunities for members to protect their higher lifetime allowance through fixed protection – in 2012, 2014 and 2016.

On these occasions someone applying for fixed protection got to keep the higher lifetime allowance, and higher tax-free cash entitlement. But only as long as generally they stopped contributing or stopped building up benefits in a defined benefit scheme.

	Protected lifetime allowance	Max PCLS
Fixed protection 2012	£1.8 million	£450,000
Fixed protection 2014	£1.5 million	£375,000
Fixed protection 2016	£1.25 million	£312,500

Protected lifetime allowance Max PCLS Fixed protection 2012 £1.8 million £450,000 Fixed protection 2014 £1.5 million £375,000 Fixed protection 2016 £1.25 million £312,500

From 6 April 2023, fixed protection members can ‘break’ these protection rules and re-start contributions to their pension, whilst keeping their tax-free cash protection. This is as long as they had already applied for their fixed protection before 15 March 2023.

David applied for fixed protection 2012 in March 2012. His protected lifetime allowance is £1.8 million, and his maximum PCLS is £450,000.

In June 2023, David contributes £180,000 into his pension fund, using his current annual allowance and carrying forward all his unused annual allowance from the previous three tax years. (He has earnings to support this high a contribution.)

In the following December, his fund is worth £2.1 million. His protected tax-free cash will remain as £450,000.

Primary and individual protection

Pension scheme members may have also had the choice of opting for primary (2006 only) or individual protection (2014 and 2016).

To apply for these protections, their pension value had to be above a certain amount. They could apply to protect their pension value at this amount and carry on contributing to their pension or building up benefits in a defined benefit scheme and keep their protection. Their tax-free cash would also be protected at 25% of their protected lifetime allowance.

These members are not affected by the new pension tax rules. They can continue contributing and can continue to protect their PCLS at a higher amount, rather than being restricted to £268,275.

Late applications

Applications for primary and enhanced protection closed on 5 April 2009. Applications for fixed protection 2012 closed 5 April 2012, and for fixed and individual protection 2014 they closed on 5 April 2014.

Applications for fixed and individual protection 2016 are still open – there has never been a final closing deadline. Also, it might be theoretically possible to put in a late application for lifetime allowance protection for the earlier protections. However, although late applications have been successful in a handful of cases, it’s difficult to see many more being accepted.

For those who are successful, or who apply for fixed or individual 2016 protection on or after 15 March 2023, then for those with enhanced or fixed protection it’s worth stressing they will lose their protection – and any tax-free cash protection – if they subsequently contribute to their pension as this will ‘break’ the protection rules.

Mo applies for fixed protection 2016 on 1 June 2023. He has not contributed to a pension scheme since 31 December 2015, so his application is successful.

When he crystallises his fund in August 2023, he is entitled to a PCLS of £312,500.

However, if he had paid a contribution in, say, May 2023, he would have lost the fixed protection and instead could only take a PCLS of £268,275.

Scheme-specific protection

Finally, it’s worth mentioning scheme-specific protection of higher tax-free cash amounts continues. As a reminder, generally those with this protection can take 120% of their PCLS at A-day, plus 25% of the post A-day fund growth (and contributions if they were eligible to make them).

Any scheme-specific protection has to be fed into any calculations of higher PCLS entitlements.

Also note, that the value of any rarely encountered stand-alone lump sums (where 100% of the fund is paid at a tax-free lump sum) will be capped at their value on 5 April 2023.