In Brand Financial Training’s latest article for Professional Paraplanner, the team tackle the complexities of the Transitional Tax-Free Amount Certificate.
If there’s one thing the pensions industry loves, it’s an abbreviation. Over recent years alone, we have had the LTA, the AA, the UFPLS, the PCLS, the MPAA and the TAA. More recently, we have been treated to an LSA, an LSDBA and an OTA.
Somewhere near the top of the tree for complexity, though, has to be the recently introduced TTFAC (not to be confused with TAFKAP, who was a 90s pop star). Or Transitional Tax-Free Amount Certificate to give its full title.
To briefly explain the thinking behind this creation, under the new regime, everybody has a lump sum allowance as of 6 April 2024. The allowance was intended to limit the amount of tax-free lump sums which can be paid out to the individual from registered pension schemes during their lifetime, effectively the amount of PCLS that can be taken.
For most individuals, the new allowance will be set at £268,275. This may seem a funny and arbitrary figure, however, it was 25% of what was the lifetime allowance at the time it was abolished. The rational course of action may have been to round it up to a round amount, for example £275,000. However, that does not look to have happened.
Some individuals who had protected lifetime allowances may benefit from a higher limit, for example those with Fixed Protection 2014 will benefit from an allowance of 25% of their protected limit of £1,500,000, which gives us £375,000.
However, for those who have already accessed pension benefits, the allowance will be reduced to reflect the fact that they have already accessed benefits. The reduction will be 25% of the total lifetime allowance that they had previously used. This will be based on the percentage system. Therefore, someone with the standard lifetime allowance of £1,073,100, who has used 50% of their allowance will be entitled to a lump sum of 25% of 50% of £1,073,100, or £134,137.50.
The system, however, assumes that the individual has taken 25% tax-free cash at every benefit crystallisation event. This may or may not have actually been the case in practice. There are a number of scenarios where this might not have occurred.
The most common one you are likely to come across is probably members of defined benefit schemes who did not take the full 25% tax-free cash. For many defined benefit schemes, the tax-free cash entitlement is taken by commuting the main scheme benefits. This means that for every pound in tax-free cash that is taken, the annual pension is reduced in line with a commutation rate, for example 18:1, which would mean a £1 per year reduction for every £18 in tax-free cash taken.
Where the rate on offer was very poor then it may not have been considered good value, even allowing for the fact that the payment is tax-free. For example, a commutation rate of 15:1 at age 60 (where the member would have an approximately 25-year statistical life expectancy) would mean potentially missing out on £1 per year for 25 years in exchange for £15 now. This is something which may be considered poor value, particularly given that the scheme payments are inflation protected.
The other potential situation with defined benefit schemes would be where the scheme offered a defined lump sum as opposed to offering it by commutation. For example, some schemes, predominantly public sector ones, may offer a pension of 1/80th of final salary or average earnings with a lump sum of 3/80ths. This would mean the lump sum could not be altered and would not represent the full 25% of the value of the benefits.
It is hard to think of many scenarios where a defined contribution scheme member would not have taken the full 25% tax-free cash, particularly post A-day. Perhaps the most likely is if the scheme offered a very good guaranteed annuity rate. Some older plans offered rates of 10-11%, which is around double the typical rate available even now and far higher than the rates which have been available for the last 15 years. This is a variant on the same theme, the member may have taken the view that it was worth giving up the tax-free cash in view of the annuity rate being much higher than available on the open market.
Another scenario may be where the member has taken benefits between 2016 and 2020, which would have been tested against a lower lifetime allowance. For example, someone who took benefits of £500,000 (50%) in 2016/17 when the lifetime allowance was £1m would have taken tax-free cash of £125,000. However, for the purposes of the standard transitional calculation, they would be assumed to have taken 25% of 50% of £1,073,100, or £134,137.50.
Another one to watch out for are those who had uncrystallised benefits tested against the lifetime allowance at age 75. Under the standard calculation, they will be assumed to have taken 25% of the value of their uncrystallised benefits at age 75 as a lump sum, even if they have not really. Unlike BCEs, an RBCE (which is the name given to the taking of lump sums which are tested against the lump sum allowance) can take place after the age of 75, so it is important that the age 75 test is disregarded.
The TTFAC application means that the lump sums taken by a scheme member will be valued against the lump sum allowance in absolute terms. So if the member crystallised benefits without taking a lump sum then they will be treated as such. This ensures that the member will receive full value for their allowance.
It should be noted that care should be taken when applying for a certificate. They are irrevocable once issued and there are circumstances where this could be counterproductive. For example, if the member took benefits prior to 2016 which were tested against a higher lifetime allowance then their absolute value may be higher than their percentage against the final LTA.
In addition, members who have taken benefits from schemes with protected tax-free cash will be presumed under the standard calculation to have taken the standard 25% (in a funny quirk, this is not the same for the purposes of the lump sum and death benefits allowance. For this purpose, the full lump sum taken will be tested). If a TTFAC is applied for then the actual lump sum which was taken will be tested against the lump sum allowance. It is therefore crucial that the correct position with regards to all previous crystallisations is ascertained before applying for a certificate as they are irrevocable once issued.
The inclusion of the age 75 test has been said in some quarters to be illogical and there has been speculation that legislation may be passed to disregard it. However, there is nothing definite as of yet. A TTFAC can be applied for at any time before the first lump sum crystallisation event following the start of the 2024/25 tax year. However, cannot be applied for once that event has taken place.
For those who have had benefits tested at age 75 and have either taken protected tax-free cash or taken benefits tested against a higher lifetime allowance then unless the client has an urgent need to take tax-free cash, it may be worth holding off on applying for the certificate. If legislation were subsequently passed to disregard the age 75 test then they may subsequently turn out to be worse off as a result of applying for the certificate.
But then everybody’s a genius in hindsight.
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