Techzone

As everyone begins to get to grips with the pension planning without the LTA, there's a recurring question which keeps popping up - should clients be applying for a transitional tax-free amount certificate (TTFAC)?

Where a client holds a TTFAC, their new LSA and LSDBA are reduced by the actual amounts of tax-free cash taken before 6 April 2024 rather than an assumed 25% of their LTA usage. This can help some clients who took less than 25% tax-free cash secure an increased allowance. But the timing of when benefits were taken can also affect this decision.

Once a client goes down the TTFAC route they cannot go back to the standard 25% of LTA usage method. Before they go ahead and request one, it is therefore critical to crunch the numbers to determine whether it will actually improve their allowances.

What's new – an overview

With the abolition of the lifetime allowance, there's no longer an upper limit on the amount of pension funds or benefits that can be accrued without tax charges. But two new allowances have taken its place – the lump sum allowance (LSA) and the lump sum and death benefit allowance (LSDBA). These will limit the amount of lump sums that can be paid tax-free during an individual's lifetime and on their death.

Tax-free cash in the form of pension commencement lump sums (PCLS) and the tax-free amount of uncrystallised funds pension lump sums (UFPLS) will be tested against and use up both LSA and LSDBA.

In addition serious ill-health lump sums and lump sum death benefits will also use up the LSDBA.

Level of allowances and protection

The default amounts of these allowances are £268,275 for the LSA and £1,073,100 for the LSDBA, but individuals who have any of the fixed or individual protections in place will have their LSDBA set to the level of their protected lifetime allowance and their LSA to 25% of that figure.

Default usage

This initial level of the new allowances will be adjusted where the individual has used up some (or all) of their lifetime allowance prior to 6 April 2024.

The default calculation will look at the amount of lifetime allowance used, and 25% of that will be deducted from both the LSA and LSDBA. If a serious ill-health lump sum has been taken, then for the LSDBA, 100% of LTA usage will be deducted.

If 100% of the lifetime allowance has been used, then the available LSA and LSDBA are both deemed to be zero.

The problem with the default approach is that it assumes that 25% was taken as a tax-free lump sum every time benefits were crystallised prior to 6 April 2024, which may not have been the case. For example, those in defined benefit schemes may not have wanted to commute their guaranteed income into a lump sum and older defined contribution schemes could have had guaranteed annuity rates, so members might have wanted to use all of their fund to secure the greatest income.

To address this, HMRC allow individuals to apply for a transitional tax-free amount certificate (TTFAC), potentially allowing 25% tax-free cash to be taken with future withdrawals where otherwise there would be no tax-free cash. In addition, it may also increase the LSDBA which may be important where a lump sum death benefit is likely to be paid, e.g. a death-in-service lump sum death benefit.

Better availability through certification

Where someone can evidence that the tax-free lump sums they've taken before 6 April 2024 come to less than 25% of their amount of lifetime allowance used, they can present that to their pension scheme and ask them to produce a TTFAC. This certified figure will be the amount deducted from their LSA and LSDBA.

For TTFAC purposes, the tax-free lump sums the member has taken will be the actual monetary amounts, without any revaluation. This differs from the standard method where the lump sums are revalued in line with changes in the lifetime allowance.

A TTFAC must be in place before the first relevant benefit crystallisation event (RBCE) occurs after 5 April 2024. An RBCE is the payment of a tax-free lump sum, so no PCLS or UFPLS can be taken until a TTFAC is granted. If an RBCE occurs before a TTFAC is granted, then the certification method cannot be used and the standard calculation will always apply.

Individuals can make an application to any scheme they're a member of but, in practice, it's likely to be the scheme they're going to take their next lump sum from. They need to provide complete documentary evidence of all the tax-free lump sums they've taken, along with their lifetime allowance usage. The scheme then has up to three months to issue a certificate or, if the evidence is insufficient, refuse it.

Once the TTFAC is issued it will always apply and cannot be revoked by the individual. It can be cancelled by a scheme administrator if it is found to be incorrect.

Timing – how urgent is it?

There is no deadline for applications for a TTFAC other than the first RBCE. The urgency will depend upon individual situations.

If a TTFAC is needed for people in phased/drip-feed drawdown, where a tax-free lump sum is included in every payment, such withdrawals should be suspended immediately until the certificate has been granted. Clients who still require an income during this period could continue to take it from funds already crystallised, but obviously all of these withdrawals would be assessed to income tax.

For those who aren't currently taking any benefits, or who are under age 55 and can't yet access their funds, then there is less urgency, and they can take their time getting all the appropriate evidence together. This could be helpful if they haven't retained their documentation and need to go back to the schemes from which they've taken lump sums from to get replacement documents.

Who won't benefit

If an individual has always taken 25% as tax-free cash when they've vested a pension, and they didn't crystallise anything when the LTA was lower than £1,073,100, then a TTFAC won't give them a better allowance. In fact, if they'd taken lump sums when the LTA was greater than £1,073,100, then it could put them in a worse position as the actual amounts of cash taken are larger than the equivalent percentage of £1,073,100.

The standard calculation of 25% of the LTA used would be better for them.

Who might benefit

Where individuals have been taking their tax-free cash over a period of time, it's not always obvious if they'll will be better off with a TTFAC. Even in cases where they've taken no cash from a scheme, other lump sums taken in years when the LTA was higher could offset the amount of any gain.

An individual's complete history will be needed to see if a TTFAC would be beneficial. Lump sums taken when the LTA was higher than £1,073,100 may offset the lump sums not taken when it was lower.

Typical situations that could benefit from investigation would be:

• benefits were vested without taking any lump sums
• benefits vested during 2016/17 to 2019/20 when the LTA was lower than £1,073,100
• funds were transferred to a QROPS – LTA would have been used up but no tax-free lump sums would have been paid at the time
• those over 75 where LTA was used up by the age 75 tests (i.e. no TFC was taken)

Ultimately, the investigation is just a comparison between 25% of the amount of LTA the individual has used, versus the total off all their tax-free lump sums they've taken. And even when a TTFAC would improve the amount of tax-free cash available, it's only going to benefit those who still have uncrystallised funds, although these may be built up with new contributions.

Improving the LSDBA

While a lot of people will be looking at TTFAC to enable them to get more tax-free cash when vesting a pension, a certificate can also increase the amount of LSDBA available, which could be useful for serious ill-health lump sums paid during the member's lifetime and lump sums paid out on death.

And it might be the case that you can't improve the LSA situation with a certificate, but you still can increase the available LSDBA.

For example, if 100% of the LTA had been used as at 5 April 2024, the default position is that both the LSA and LSDBA are zero. A TTFAC might not give any additional LSA if the actual amounts of tax-free lump sums are £268,275 or higher, but it could help the LSDBA.

So, if they'd only taken a PCLS of £268,275, on successful application for a TTFAC this amount is deducted from the LSDBA of £1,073,100 (assuming no protection). This would give them an available LSDBA of £804,825, and not zero as would have been the case using the standard calculation.

Though it's worth remembering that lump sums paid from funds crystallised before 6 April 2024 won't be tested against the LSDBA, only from funds crystallised after that date or lump sums from uncrystallised funds.

Summary

The TTFAC is an important method for preserving or increasing the amount of tax-free benefits available from a pension, but obtaining one will not be the best course of action for everyone, and certainly shouldn't be applied for on a 'just in case needed' basis. Both methods of calculation should be compared before going ahead. It should be remembered that once the certificate has been granted, it cannot be reversed.

Those who are actively taking benefits and who think a TTFAC will help are those that need to consider this without delay, as they need to apply before any new tax-free lump sums are taken. Getting the full evidence of the lump sums paid will mean the individual digging out their old records or getting copies from the schemes that originally paid them, and if this can't be done, then a certificate won't be issued.

To help with the decision-making process, see our new decision tree: 'Who should consider applying for a TTFAC?'