Maximising protected tax-free cash

Whilst 2024 ended with a lot of doom and gloom in the pension world following the big announcement on IHT, there was some good news that may have slipped under the radar of some advisers.

Amongst the regulations that came into force in November, were clauses that dealt with scheme-specific lump sum (SSLS) protection – the old A-day protected tax-free cash.

Prior to these regulations, clients with SSLS were in limbo, as, following the removal of the lifetime allowance, the legislation didn’t deal with their benefits as intended.

Those with SSLS can now take their protected lump sum, and the maximum is calculated in a similar way as it would have been under the lifetime allowance rules. Broadly, their 6 April 2006 lump sum is increased by 20%, plus 25% of benefits accrued since.

However, under the new regime, the way the rules work means the order that benefits are taken can have a big impact on the amount that clients can receive tax free. This is because it is only a requirement to have available lump sum and death benefit allowance (LSDBA), not lump sum allowance (LSA), to pay the SSLS tax free.

For example, Laura has not yet taken any pension benefits. She has £1.2 million in her SIPP with no protection, and a section 32 policy valued at £500,000 with an SSLS of £175,000.

SSLS use up LSA as though 25% PCLS is taken, even though the actual amount taken is higher. One of the rules when taking an SSLS is that the whole lump sum must be taken in one go, so LSA used is 25% of the pension accessed when the SSLS is taken.

If Laura takes her SSLS first, this uses £125,000 of her LSA (25% of £500,000), leaving £143,275 LSA to take PCLS from her SIPP. Her total tax-free cash would be £318,275. Her LSDBA is reduced by the amount actually taken, so the remaining LSDBA would be £898,100.

If, instead, she takes the full £268,275 PCLS from her SIPP first, this will use up all her LSA, but she can still take the full £175,000 SSLS from the section 32, as she has plenty of LSDBA remaining. By taking benefits this way round, she can have £443,275 tax-free – a massive £125,000 more than if she’d accessed the section 32 first.

There won’t be huge volumes of clients with SSLSs and substantial other funds, but for those few that meet the criteria, the difference in the order that they access their pensions can make a significant difference.