Finance Bill allows more tax free cash

A change announced in the Finance Bill published last Thursday (27 March 2008) will allow some people to take more of their pension benefits as a tax-free lump sum.

The pension tax changes introduced from 6 April 2006, A-Day, introduced a standard tax-free lump sum entitlement of 25% of the individual's pension benefits. Those members who were entitled to a lump sum larger than 25% could protect this higher amount.

Those people who had a greater entitlement can also receive an additional 25% of any money built up after A-Day in addition to their protected amount. But to receive this additional amount an individual had to be treated as being a member after A-Day. This could be achieved by the individual paying a £1 contribution to his or her scheme.

The Government has decided to simplify the calculation and this results in people no longer needing to have built up benefits after A-Day in order to receive the additional amount (i.e. they don't need to pay the additional £1 contribution).

Andrew Tully, Senior Pensions Policy Manager at Standard Life said: 'This change will allow up to 1 million people, especially those who left schemes before A-Day, to take more of their benefits as a lump sum. It will especially benefit those people who were not able to pay additional contributions into old pre A-Day arrangements, for example members of final salary schemes. The simple pension rules introduced in 2006 have already become too complicated, although this change is a small step in the right direction to true simplification.'

Example

John had a fund of £100,000 at A-Day and a tax-free lump sum of £50,000. At his retirement date of 2010, his fund has grown to £140,000. He has made no contributions since A-Day.

Currently his lump sum is the protected amount at A-Day which is increased in line with the increases in the lifetime allowance. The lifetime allowance was £1.5m in 2006 and will be £1.8m in 2010. So John's lump sum would have been £50,000 x 1.8/1.5 = £60,000.

Under the new rules introduced in the Finance Bill, John will also be able to get an additional 25% of the fund which is deemed to be built up after A-Day. John's fund at A-Day was £100,000 and again this is deemed to increase in line with the lifetime allowance so notionally it will have grown to 100,000 x1.8/1.5 = £120,000. So the fund built up after A-Day is £140,000 - £120,000 = £20,000. 25% of this amount can also be taken as tax-free cash giving an additional £5,000.

So John's total lump sum under the new rules is £65,000 rather than £60,000.

The changes, which will be backdated to 6 April 2006, are set out in Paragraph 13 of Schedule 29 to the Bill. Although the change won't become law until the Bill becomes an Act (probably in late July), HMRC have confirmed that the new rules can be used with immediate effect.