There are many reasons why people seek to transfer rights held in one pension scheme to another. For example, they might want to access a particular investment or benefit payment option not available under the existing scheme.  

    Whatever the reason, understanding the tax implications of transferring is an important part of the advice process.

    The following case study looks at the implications in terms of the Annual and Lifetime Allowances where rights are being transferred from a Defined Benefit (DB) arrangement to a Self-Invested Personal Pension (SIPP).

    Transfer to a SIPP?

    Rachel, 58, is an active member of a DB scheme. She’s considering taking benefits before the end of the current tax year. The flexible retirement and death benefit options of a SIPP appeal to her and she wants to know if there are any tax issues if she transfers to a SIPP before immediately accessing benefits.

    Pension accrued at the end of 2021/22 tax year was £35,000 p.a. Consumer price index (CPI) September 2021 was 3.1%.

    Cash equivalent transfer value (CETV) is £1,125,000 and represents the actuarial value of the pension accrued at date of leaving, i.e., there’s no reduction or enhancement of the CETV.

    Options under the DB scheme at date of leaving: pension of £37,500 pa or £187,500 PCLS and a residual pension of £28,125 pa (scheme commutation factor is 20).

    Annual allowance: 2022/23 Pension input amount (PIA) for DB scheme

    Opening value (OV) = 16 x £35,000 x 1.031 = £577,360

    Pension accrued at end of 2022/23 is nil

    Closing value (CV) = nil + (16 x £37,500) = £600,000

    PIA = CV – OV = £22,640

    2022/23 PIA for SIPP is nil, assuming no contributions are paid into the SIPP in the tax year.

    The calculation of the CV is adjusted to reflect the actual amount of accrued pension at the time of the CETV.

    Rachel is not subject to tapering of the Annual Allowance. Therefore, there would be no Annual Allowance charge to account for in the current tax year.

    Lifetime Allowance: amount crystallised on taking benefits

    DB scheme = £187,500 + (20 x £28,125) = £750,000

    Rachel has no lifetime allowance protection. Transferring and using all her SIPP fund to provide benefits would result in a Lifetime Allowance charge as her SIPP fund of £1,125,000 would exceed her Lifetime Allowance of £1,073,100. Assuming, she leaves the Lifetime Allowance excess within the SIPP, the breakdown of her benefits would be as follows:

    PCLS = £268,275 (25% of £1,073,100), Drawdown = £843,750, LTA charge = £12,975

    The PCLS available from the SIPP is greater when compared to the DB scheme. However, the lifetime allowance used up under the SIPP is also greater. This is because the CETV represents more than 20 times the pension accrued at date of leaving.

    Lifetime and annual pension allowance

    Being able to quantify the impact of any transfer in terms of the Annual and Lifetime Allowances is important because if an Annual Allowance and/or a Lifetime Allowance charge arises there’s a need for the transferring individual to account for it through self-assessment.  

    In Rachel’s case, it’s a Lifetime Allowance charge if the transfer goes ahead.

    Staying with the Lifetime Allowance. Where the transferring individual holds either enhanced or one of the forms of fixed protection, the transfer must be a ‘permitted transfer’ if they are to retain the protection.

    Registered pension scheme

    To be a permitted transfer, the receiving arrangement must be under a registered pension scheme or a recognised overseas pension scheme and the value of the rights before and after the transfer actuarially equivalent. Where the receiving arrangement is money purchase (not cash balance) in type no further conditions apply. However, further prescribed requirements must be met where the receiving arrangement is defined benefit or cash balance.

    A permitted transfer from a defined benefit or cash balance arrangement to a money purchase arrangement (not cash balance) triggers a test for relevant benefit accrual where enhanced protection is held by an individual. If relevant benefit accrual occurs, enhanced protection is lost. Relevant benefit accrual occurs when the amount transferred exceeds the appropriate limit as defined in legislation.

    Tax legislation, including the annual and lifetime allowances, is just one consideration. The transfer contemplated in the case study involves safeguarded benefits and comes within the Financial Conduct Authority’s remit on advising on pension transfers, a regulatory minefield not considered here.

    Transferring pension rights demands serious scrutiny as doing so is likely to be irreversible. That being the case, it’s essential that individuals faced with such an important decision get access to advice that can be relied upon. This presents advisers with the challenge of ensuring that all relevant factors are identified to enable their clients to make well informed decisions.  

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