Scheme-specific protection is a form of transitional protection – in other words, protecting pension rights that accrued before a major rule change. In this case, we are concerned with tax-free lump sum rights that arose in a particular scheme before 6 April 2006 (‘A-Day’) that are specific to that scheme. Retirement ages could also be protected in specific schemes. Other forms of transitional protection, by comparison, apply across all the member’s registered pension schemes. Lump sum entitlements protected under enhanced or primary lifetime allowance are treated differently and are out of scope of this article.
Members did not need to apply to HMRC for this protection. It was all documented by the scheme administrators of the schemes concerned.
What lump sums are protected under these rules?
Following pensions simplification, the maximum pension commencement lump sum (PCLS) a member can take is the lower of 25% of the value being crystallised and 25% of the member’s available lifetime allowance.
For most members of registered pension schemes, the lump sum rules applying now are at least as favourable as the rules that applied before 6 April 2006. However, there are some members whose lump sum rights at A-Day exceeded 25% of their fund value due to the previous calculation methods.
For these members, a degree of protection is given for their lump sum rights as they stood at 5 April 2006.
These lump sum rights will have accrued under occupational schemes or deferred annuity contracts. Tax-free cash of more than 25% wasn’t available in personal pension schemes.
As the rights were held in specific schemes, it was decided that scheme administrators could document the protected amounts themselves based on their A-Day records. There are no certificates for this form of protection.
There are three conditions that must be met for scheme-specific protection to apply:
- the benefits must be paid from the scheme in which the rights were held on 5 April 2006 (the original scheme) or a registered pension scheme to which the rights were transferred as part of a block transfer after 5 April 2006;
- the uncrystallised lump sum rights in the original scheme on 5 April 2006 were more than 25% of the value of the uncrystallised pension rights in the scheme on that date; and
- the member must become entitled to all their pension and lump sum rights (that were not in payment on 5 April 2006) under the scheme on the same day.
Protected PCLS in practice
The maximum PCLS a client with scheme specific protection is entitled to is:
- the monetary amount the member was entitled to at A-Day, revalued in line with changes in the lifetime allowance since that date (‘LS’);
- an additional lump sum amount (‘ALSA’) which is broadly equivalent to 25% of the fund growth, contributions and transfers-in since A-Day.
- LS =
£ tax-free cash at A-Day x 120%*
- ALSA =
[£ total fund value – (A-Day fund value x standard LTA / £1.5 million)] x 25%
Having calculated the protected lump sum, you calculate the additional lump sum amount. The two are then added together.
*This uplift will be 120% until such time as the standard lifetime allowance rises above £1,800,000.
At A-Day, Mr Pike had lump sum rights of £50,000 and a total uncrystallised fund value of £100,000.
Mr Pike makes contributions to the scheme and then takes all his benefits from the scheme on 26 April 2021.
His total fund value is now £220,000.
Mr Pike’s lump sum is calculated as follows:
- LS =
£50,000 x 120% = £60,000
- ALSA =
(£220,000 – (£100,000 x £1,073,100 / £1,500,000)) x 25% = £37,115
Mr Pike’s total PCLS is therefore:
£60,000 + £37,115 = £97,115
Interaction with fixed and individual protection
A member with a scheme-specific protected lump sum may have subsequently applied for one of the types of fixed or individual protection. There is a slight quirk in the calculation for these members.
The A-Day lump sum is calculated in the same manner as outlined above. However, the additional lump sum amount calculation uses the protected lifetime allowance rather than the current standard lifetime allowance. This can result in the member receiving a lower PCLS than they would have done without the additional fixed or individual protection.
Rights that benefit from scheme-specific protection are – as the name suggests – specific to the pension scheme where the rights were accrued and are usually lost on transfer. However, if a ‘block transfer’ (sometimes also known as a ‘buddy transfer’) is made, then the rights can be carried across to the new scheme.
There are three conditions for a transfer to be a block transfer. All three must be satisfied for the protection to be retained.
- There must be two or more members. All members involved in the block transfer must be transferring from the same transferring scheme to the same receiving scheme.
However, there is no requirement for both members to have scheme-specific protection – so one member with protection could ‘buddy up’ with someone who has no protection.
- All of the sums and assets relating to those members must be transferred as a single transfer
The instruction to transfer for both/all members must come through as one request. It does not mean that all assets must be transferred on the same day, as this may not be practical – especially when transferring in specie. Partial transfers cannot satisfy the block transfer conditions.
- None of the members can have been a member of the receiving scheme for more than 12 months prior to the (completion of the) transfer.
Setting up a new arrangement within a scheme the individual has already been a member of for more than 12 months would not get round this issue. It must be a completely separate scheme (with a different pension scheme tax reference (PSTR) from HMRC).
If any of the conditions are not satisfied, the transfer cannot be a block transfer. It could still be a recognised transfer, so there are no unauthorised payment issues. However, the member would lose their right to the protected benefit entitlement on the funds that were transferred to the new scheme. If any funds remained in the transferring scheme, these would still retain the protection.
There aren’t any restrictions on the type of scheme that can accept a block transfer. However, it’s not possible to do a block transfer from a retirement annuity contract or a deferred annuity contract (Section 32 policy), as these schemes only have one member, so a transfer could never meet the block transfer criteria. If someone has a protected PCLS under a one-member scheme, then the statutory permissive override may be useful to allow them to take the protected amount and still access flexi-access drawdown rather than having to purchase an annuity. See the section below for more information.
If an individual has scheme-specific protection in relation to more than one pension scheme, it is not possible to consolidate these into one scheme and keep all the protected amounts, even if the block transfer conditions are met. The protection is only retained in respect of the first transfer.
When it comes to accessing the pension, the fund must be fully crystallised to use the protection (this is also the case for protected retirement ages); it is not possible to partially crystallise. This includes any other funds that have been transferred in, or contributions made, that didn’t originate from the scheme where the protection was acquired.
However, if someone fully crystallised, they can continue making contributions, or transfer other funds in, and take these at a later date. The crucial point is that they must crystallise everything that is in the pension fund at the time of the benefit crystallisation event.
Statutory permissive override
When pension freedoms were introduced in 2015, there were many changes that needed to be made in a short space of time. To help with this, legislation was put in place that meant any money purchase arrangement could offer the new types of flexible pension payments without having to update their scheme rules. This statutory permissive override can be found in the Finance Act 2004 s273B and allows payments of drawdown pension for members, dependants, nominees and successors, along with other pension freedom payments.
This means any money purchase pension scheme can designate funds to drawdown for the member or, on their death, for their beneficiary, regardless of what is written in their scheme rules. If the original scheme does not have the functionality to physically make the payments of drawdown income, then they only need to pay out the PCLS, make the designation and then make a like-for-like drawdown transfer to a scheme that can facilitate the payments. Once the right to a protected lump sum has been used, the subsequent drawdown-to-drawdown transfer does not need to be a block transfer.
This could help clients with single member contracts containing protected lump sum rights who would otherwise be unable to access income drawdown with their residual funds if the only income option in the scheme rules was an annuity. The original ceding scheme could still choose not to facilitate this, as the member is not able to enforce use of the override.
The receiving drawdown scheme will need confirmation:
- that the funds are designated into flexi-access drawdown in the member’s name;
- of the date of designation;
- of the amount designated; and
- of whether the MPAA has been triggered.
In practice, the MPAA will never be triggered if the ceding scheme does not have the ability to pay income, but the ceding scheme needs to include this in its written confirmation to the new scheme.
This article was previously published by FT Adviser.
Financial adviser verification
This area of the website is intended for financial advisers and other financial professionals only. If you are a customer of AJ Bell Investcentre, please click ‘Go to the customer area’ below.
We will remember your preference, so you should only be asked to select the appropriate website once per device.