How to unlock more tax-free cash from your pension

As the landscape of pensions continues to evolve, understanding the nuances of regulatory changes is paramount for maximising tax efficiency and optimising your financial plans.

One recent development is the introduction of Transitional Tax-Free Amount Certificates, which offer a bespoke approach to deductions from the Lump Sum Allowance and Lump Sum and Death Benefit Allowance.

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But if this all sounds like jargon and hard to wrap your head around, lets us better explain as we delve into the intricacies of these certificates, examining eligibility criteria, potential benefits, and potential drawbacks. Our primary focus will be on illustrating how these certificates can potentially benefit Defined Benefit pension holders (also known as a final salary scheme, but also include public sector schemes for example, Career Average Revalued Earnings or CARE) through a detailed calculation demonstrating the potential impact on their tax-free cash entitlement at retirement.

What are Transitional Tax-Free Amount Certificates?

Transitional tax-free amount certificates serve as tools to accurately reflect tax-free lump sums received before April 6, 2024, within the new pension framework. They are issued by registered pension schemes, allowing members to increase the level of tax-free cash available to them.

The Lump Sum Allowance sets the tax-free lump sum a pension holder can withdraw from their pension pot during their lifetime. This is currently standardised at £268,275; however, this can vary depending on individual protections. Pension Protections were introduced to protect pension savings from previous reductions in the Standard Lifetime Allowance.

The lump sum and death benefit allowance governs the tax-free lump sum payments beneficiaries can take following the pension holders passing and is currently set at £1,073,100. However, this may be reduced by tax free lump sums already taken by the member.

For individuals who accessed their benefits post-April 5, 2024, a standard transitional calculation is used to ensure adjustments are made to the lump sum allowance and lump sum and death benefit allowance. In most cases this standard calculation effectively reflects past benefits utilised and aligns correctly with the new regulatory framework. However, in certain circumstances, some individuals may qualify for a higher allowance by applying for a transitional tax-free amount certificate.

For Defined Benefit Pension Scheme members, two such circumstances are as follows:

• Members of Defined Benefit Pension Scheme where they opted to take a full scheme pension and did not receive a tax-free lump sum. 
• Members of a Defined Benefit Pension Scheme who received a tax-free lump sum which was less than 25% of the pension’s value for lifetime allowance purposes (calculated as 20x the pension, plus any tax-free lump sum).

In these circumstances transitional tax-free amount certificates may offer a bespoke adjustment to the lump sum allowance and lump sum and death benefit allowance, ensuring a more accurate representation of the individuals tax-free lump sum entitlement. By accounting for actual lump sum benefits received, before the regulatory shift, transitional tax-free amount certificates provide a tailored approach that may prove advantageous for some pension holders.

Impact for Defined Benefit Pension Holders:

Here we will provide an example situation to further clarify how transitional tax-free amount certificates could provide a benefit to an individual who has taken tax-free cash under the 25% from their Defined Benefit Scheme.

Scenario: 

Tom decided to begin drawing income from his Defined Benefit Pension t in 2020/2021. He took pension income of £27,500 per annum and chose to take tax free cash of £50,000.

If we assume Tom has Fixed Protection 2012 (giving him a Lifetime Allowance of £1,800,000) taking these benefits used up 33.33% of his Lifetime Allowance (£27,500 x 20, plus £50,000 = £600,000 which is 33.33% of £1,800,000).

As this example explores, if you have not taken your full tax-free cash entitlement, you could be entitled to a larger lump sum allowance and lump sum and death benefit allowance by applying for a transitional tax-free amount certificate. This could allow you to take more tax-free cash from any other pension schemes you may hold and the implications of this could be significant. In this example, c. £100,000 of additional tax-free cash could be available to the individual, though please note this is still based on 25% of the value of any pension funds from which tax free cash has not yet been taken (for defined contribution pensions). Therefore a £400,000+ pension pot would be required to take full advantage of the additional tax free cash which is now available.

How to apply for transitional tax-free amount certificates:

Eligible individuals must submit a transitional tax-free amount certificates application to the pension scheme before taking any tax-free cash post-April 5, 2024. The success of a transitional tax-free amount certificates application hinges on the provision of complete and accurate evidence verifying the individual's entitlement to a reduced deduction from lump sum allowance and lump sum and death benefit allowance. Applicants must thoroughly compile documentation demonstrating their actual tax-free lump sum entitlements before April 6, 2024, ensuring compliance with regulatory requirements.

Potential pitfalls of applying for transitional tax-free amount certificates

While transitional tax-free amount certificates offer tailored adjustments to allowances, individuals must carefully evaluate the potential impacts on their pension benefits. Notably, calculations can vary significantly from individual to individual. For example, not everyone who took less than their 25% tax-free cash will benefit from applying for transitional tax-free amount certificates. In some cases, the issuance of a certificate may result in a reduction of allowances. If the outcome proves to be unfavourable creating less tax-free cash entitlement after applying for the certificate, this decision cannot be reversed.

How we can help

In this article we delved into the potential benefits offered to individuals with Defined Benefit pensions by the new Transitional Tax-Free Amount Certificates. If you believe this could be advantageous to you, it is important to seek financial advice before proceeding further. The possibility of this decision weakening your future pension position underlines the need for a comprehensive analysis of your previous benefits taken across your pension schemes.

At The Private Office we offer the guidance required to navigate these complex changes to pension legislation, ensuring that you are positioned optimally for your future and that you maximise the tax efficiency of the benefits you are entitled to. We can provide tailored financial advice to aid you in establishing the impact of transitional tax-free amount certificates on your specific situation, and we can assist you by preparing your application for potential submissions to your pension scheme providers, should these prove advantageous.

If you would like to schedule a call with one of our advisers, please get in touch. We can arrange an initial meeting at no cost and with no obligation, to further explore your own personal situation together.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate tax advice.

A pension is a long-term investment. The value of an investment and the income from it could go down as well as up.  The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

The information in this article is based on current laws and regulations which are subject to change as at future legislations.