Advisers must ensure they now have all the information needed for clients who were members of pre-A-Day occupational pensions to claim tax-free cash settlements before the records are lost.
Many clients who were members of occupational pension schemes before A-Day are entitled to a tax-free cash settlement but time is running out to obtain all the information needed to claim this benefit.
Analysis of our clients who are members of occupational pension schemes shows that a relatively high proportion of them have a tax-free cash entitlement that is protected under the A-Day rules.
A-Day legislation did not specify a deadline for when the tax-free lump sum cash they had built up under those schemes must be calculated. In recent practice, the calculations have been made when the client either reached retirement or decided to transfer the benefits into another registered scheme.
However, the time constraints around the storage and availability of the required data may force advisers to act earlier if they are to preserve any valuable pre A-Day tax-free cash benefit to which the client might be entitled.
To enable A-Day cash calculations to be correctly completed, information relating to employment held prior to 6 April 2006 must be provided. This includes:
Salary, bonus and other taxable benefit information for the employment concerned for up to 13 years of service prior to A-Day;
The value of the scheme benefit at A-Day;
The A-Day value of additional pension schemes related to the same employment;
The value at A-Day of pension benefits related to earlier periods of employment or self-employment.
Four years on from A-Day, finding the required data for the calculation can prove to be a problem. Employers may have some records but are only required legally to hold PAYE records for three years prior to the current tax year. HM Revenue & Customs holds records for only six years prior to the current tax year and the pension provider in many cases will not have complete year-on-year remuneration records.
Knowing that these records will become increasingly hard to obtain, advisers may choose to obtain this information and put it on file while it is still available. If advisers choose to wait until their clients reach retirement or decide to consolidate policies, they may find that the information required to make the necessary calculations is unavailable.
Not having access to the relevant information can affect the benefits the client will receive, including:
A lifetime allowance indexation of 20% of the A-Day protected cash entitlement that applies regardless of underlying investment performance;
A potentially significant reduction in the amount of tax-free entitlement that individuals may hold in their occupational pension scheme funds;
Any tax-free cash entitlement that is lost will be converted into income (annuity or income withdrawal) on which income tax will be charged – this may be basic rate or higher rate income tax depending on individual client status.
A case study
Consider, for example, a client who joined their employer’s occupational scheme in April 1990, having completed four years of service with the employer. At A-Day, having completed 20 years’ service, the value of the pension fund was £80,000. The best year of salary was 2005-06 when the client had a total income of £60,000 with no bonuses or other taxable benefits to take into account.
Under pre A-Day legislation, the client’s A-Day tax-free cash calculation would deliver a benefit of £45,000 (3/80ths x 20 years of service x £60,000). This is a protected tax-free cash entitlement as it represents more than 25% of the A-Day fund value and if the adviser had arranged for this calculation to be undertaken, the scheme would record £45,000 as a protected A-Day entitlement.
The client is now looking to retire and their pension fund is now worth £120,000. Because the A-Day cash calculation had taken place, the client would be entitled to a tax-free lump sum of £60,000 from that fund.
This is made up of two elements:
The A-Day protected cash figure of £45,000 multiplied by the increase in the lifetime allowance of 20% = £54,000; and
25% of the investment growth on the A-Day fund value after discounting the increase in the lifetime allowance, ie, 25% of £120,000 – ( £80,000 x 1.8/1.5) = £6,000.
If the calculation had not taken place and the client was unable to provide the salary information, the pension commencement lump sum would be restricted to £30,000 – 25% of the fund. In this example, the client would lose 50% of their tax-free entitlement as a result of action not being taken to obtain an A-Day tax-free cash calculation.
Take immediate action
Advisers with clients in this position should obtain the information outlined above and forward it to all relevant scheme providers and administrators requesting an A-Day cash calculation to be produced.
Once this calculation is made, the adviser can identify any possible preparatory activities for the client’s future retirement planning.
A-Day is now four years old but nevertheless advisers should continue to review clients with pre-A-Day occupational scheme benefits that have transitioned into the new regime.
If no immediate action is taken for clients with occupational scheme benefits, there is a possibility that the information required will not be available and as a result clients will lose the valuable pre-A-Day tax-free entitlements that they would otherwise enjoy.
Adrian Walker is head of retirement planning at Skandia.