Pension rules were devised with the paternalistic objectives of encouraging savings and then ensuring stable and sustainable incomes throughout retirement. The wealthy can exploit these rules differently from people largely or entirely dependent on pension schemes to deliver their retirement ‘income’.  Within the constraints of the rules, they have choices about how much to save in pensions and how much to draw from pensions that are driven entirely by externalities like tax efficiency or by a combination of personal objectives and tax. If they made themselves heavily dependent on payments from pension plans to fund their retirement spending, it was because they were either advised by someone who did not know how to game the rules successfully (accountants often got this wrong) or were not advised at all. We approach the latest round of pension changes, still in draft form in the 2011 Finance Bill, in this spirit.

The idea that financial decisions subject to rules might be made easier by applying strategies honed in competitive games ought not to be unfamiliar to wealthy investors. Even if it is unfamiliar it ought not to be counter-intuitive.

Winning in this context is about maximising the after-tax cash flows from personal pension funds but doing so as part of a holistic plan that maximises personal welfare, or benefit, from all forms of wealth and in terms of all different personal goals, of which securing lifetime spending is just one, albeit perhaps the highest, priority. This is how we develop wealth strategies collaboratively with our clients.

The Coalition Government’s contribution to the pensions regime that was last overhauled in 2006 is a series of changes to the rules, some of which reduce flexibility and some increase it. It is flexibility that determines the scope to game the rules.

Seeking advice

We highlight below the changes and the possible implications for winning strategies. If you think this applies to you, it is likely you will need to take professional advice.

• The typical scale of the difference between optimal and suboptimal decisions in this area makes paying for good advice entirely logical.
• You should not assume that because you have an adviser in place or that you took advice at A Day that you do not need to check whether your strategy is now or ever was optimal.
• You should not assume that this is just about searching for information and tips on the internet and managing your own retirement plan. Optimal decision making in conditions of uncertainty about capital markets and inflation, when subject to complex tax and other rules as well as uncertainty about future changes in those rules, is a massive challenge for professional advisers let alone self-directed investors.

At NMB, retirement planning is an important part of ensuring ‘capital efficiency’ across the whole of a family balance sheet. In wealthy  households, where there are resources available to meet multiple goals that deliver very different forms of benefit or favour different beneficiaries, capital efficiency as a conceptual approach to managing finances integrates each of

• maximisation of goal-based welfare
• effective risk management
• minimisation of tax
• avoidance of unnecessary costs.

Given its obvious importance in your life, you should ask yourself why financial management ought not to be one of your largest budget items and why you would not give it the attention it deserves. 

Changes in the next Finance Bill

Contributions

• 5th April 2011 is the last chance for individuals not caught by ‘regular contribution’ rules to make large contributions in their final year before ‘retiring’ (ie crystallising benefits) and gain tax relief at their marginal rate on up to £255,000 of UK relevant earnings.
• From 6th April, those caught by the regular contribution rules will be able to make up the difference between Labour’s cap on tax relief of £20,000 pa and the new cap of £50,000, reaching back up to three  years.

Should you make further contributions? You will want to consider the following.

1. Anyone making contributions should avoid the mistake of assuming that the after-tax cash flow values are higher in a pension wrapper than out. Recommendations usually focus on the tax relief going in and tax free ‘rollup’ and ignore the tax treatment of the money coming out, which effectively includes a charge on the apparently tax-free rollup. Increased marginal tax rates, if these survive through much of a retirement phase, affect this comparison significantly. At higher marginal rates in retirement than when saving, the net present values of a stream of lifetime cash flows generated from a pension fund is likely to be less than the value of a flow generated outside pensions. Ironically, the comparative values also depend critically on assumptions about death and IHT treatment. Finally, they are also sensitive to what investments you would hold.
2. Contributions also need to tie in with the Lifetime Allowance and any protection you have or could have in place.
3. Think about whether your retirement spending will be too heavily dependent on externally-imposed drawdown rules. There has to be a balance between capital in and out of pension pots because the drawdown rules conflict with the typical spending profiles in affluent households that are front-loaded and with typical plans to fund later stages with property sales. Pensions may not provide the spending power when you need it.

Drawdown

• If the Finance Bill passes, the drawdown regime will be the same before and after age 75 and will be referred to as Capped Drawdown. This was presented as an end to compulsory annuities at age 75 but in fact wealthy people could have avoided the penal drawdown rules after 75 by moving to a plan written under ‘scheme rules’. So there is no real gain in flexibility.
• Contrast this with the fact that everyone planning to take benefits before age 75 by drawdown is affected by a reduction in the maximum draw. If the Finance Bill passes, between 0% and 100% (currently 120%) of the Government Actuary Department (GAD) rate (derived from a gilt yield and age) can be taken as drawdown instead of buying an annuity. This is a significant loss of flexibility and increases the risk of excessive past contributions causing timing problems for spending.
• Flexibility is also lost because the resulting drawdown rate is based on a capital value at intervals of three years, down from five years, if the Bill passes. A fall in markets can therefore trigger a fall in maximum draw, if the fall in triennial valuation exceeds the upward drift of the GAD rate with age. Longer periods offer greater flexibility to manage the profile of the draw.
• There is still a slim chance an individual already in drawdown can request a new valuation basis before 5th April but HMRC only allow this on the anniversary of a previous valuation.
• These rules are also impacted by transfers from one provider to another.

These constitute prima facie reasons for bringing forward the crystallisation of benefits and start of draw before 5th April 2011 – but subject to the personal relevance of the next two sections.

Death benefits and IHT

• Up until such time as the tax free cash is drawn from the pension, the whole fund can be passed, on death, to your chosen beneficiary(s) as a lump sum without any income or inheritance tax (IHT) consequences. Once the fund has been crystallised, or you reach age 75, this option is lost. Though not a change, it is inconsistent with the principle espoused by the Treasury that tax relief already given should be recovered either by income tax on benefits taken as income or as a Tax Recovery Charge set at 55%. Death before 75 remains an exception to this rule, unless Parliament questions it.

Should you therefore opt for phased crystallisation? Under existing rules for drawdown, tax free cash can be spread across a number of years by crystallising part of the plan each year (the plan normally being divided into ‘segments’). The drawdown options are then applied to each ‘opened’ segment. Because each crystallisation produces both a tax free sum and a stream of payments, manufacturing an even stream across time means all the plan segments will be opened in the first decade of draw rather than spread across the plan. Phasing crystallisation therefore competes significantly with the tax-efficient disposition of death benefits on unopened segments.

How you make this trade off depends critically on the strength of any bequest motive competing with lifetime spending or gifting. The mathematical impact of the probability of death before 75, combined with a bequest motive, also influences whether to take advantage of the main change in drawdown affecting the wealthy: flexible drawdown.

Flexible drawdown

• The Finance Bill proposes to give complete flexibility on drawdown provided an individual can satisfy a Minimum Income Requirement (MIR) of £20,000 pa in the form of pension annuities or defined benefit scheme benefits (including State pension). It prevents a member who expunges their fund from falling back on State benefits. This test only has to be met once.
• The decision approach will vary if an individual can satisfy the MIR from final salary scheme benefits and the State pension. Otherwise, the price of meeting the MIR is an annuity purchase from the personal pension pot which potentially conflicts with the objective of the increased flexibility.

Compared with phased Capped Drawdown, the option provides more scope to control a changing rate of draw, such as to minimise personal income tax, potentially leaving more of the fund open to the impact of death before 75. Individuals may have opportunities to exploit brief windows of low personal taxation due to their personal circumstances – although this aspect of the draft legislation may attract attention in debate.

Lifetime Allowance

• The Finance Bill also alters the Lifetime Allowance of pension benefits (by capital value equivalent) from £1.8m to £1.5m. Any breach will be tested cumulatively with each crystallisation event, including occupational scheme benefits. Any excess will be subject to a tax charge of 25% (as currently).
• The Lifetime Allowance will be tested again at age 75 (as currently) to ensure that people who defer drawing and have then exceeded the allowance pay the 25% charge, as a disincentive to using deferral as a strategy for mitigating IHT. Flexible drawdown could help in managing the combined chance of death before 75 and a 25% charge at 75.
• To protect people who had already planned on a limit of £1.8m (and did not have any form of protection under the original ‘A Day’ regime) from inadvertent breach, as a result of the impact of unknowable investment growth on contributions already made, it will be possible to apply for Fixed Protection to ensure that their personal limit is £1.8m not £1.5m.
• As a condition of Fixed Protection, a member would have to make no further contributions so anyone planning this might want to consider making a final contribution before 5th April 2012.
• Deferred and active members of a defined benefit scheme are also affected (differently) by rules on the accrual of benefits and therefore risk a breach of their Fixed Protection.

Though not a change, the management of the risk of breach is highly sensitive to assumptions about nominal investment returns and future government policy about moving the Lifetime Allowance up if inflation turns out to be driving returns above protected levels. Planning is therefore a hostage to political fortune as well as to the uncertainty of real, post-inflation investment returns.

Managing the second risk assumes skills in modelling real investment returns probabilistically. It is not enough to rely, as most advisers do, on deterministic nominal return projections. In most cases, the same projection rates are used as the FSA prescribes for pension providers yet financial planners are under no obligation to use these non-probabilistic (and over-simplistic) assumptions. Good risk management is obviously about stress testing, not relying on assumptions that have only a 50% or so chance of being reached.

Continuous reprojection of probable outcomes, in real terms that correspond to spending,  is a key part of the financial management you should be paying for in retirement. If your financial adviser or investment manager cannot do this, you should talk to us.

(Please note this is only open to delegates of the 2010 Clinical Radiology Annual Meeting )

By attending this short seminar attendees will gain a greater understanding of the NHS Pension Schemes, enabling them to;

• Understand the primary differences between the 1995 and 2008 NHS pension schemes
• Determine which one of the two schemes is likely to be most appropriate for them
• Calculate the deemed value of their NHS pension
• ‘Game’ the pension rules in order to maximise the level of pension benefit
• Determine whether they are on course to breach the Lifetime allowance and what it means if they do

For those with privately funded pensions supplementing the NHS Scheme, Joe will go on to;

• Set out why the investment approach should differ between ‘accumulators’ and ‘decumulators’
• Help you to understand which aspects of planning will have the greatest impact on retirement outcomes
• Discuss practical measures that allow you to keep control of costs
• Highlight practices that are to be avoided at all costs

And with the Coalition government setting out its pension objectives in two recent consultations, Joe will also cover the areas that are most likely to impact the seminar attendees, and so covering;

• The impact of likely changes to the pensions annual allowance
• Improved pension flexibility that is likely to come about with the introduction of a ‘Minimum Income Requirement’

Lifetime Allowance
The Lifetime Allowance (LTA) will increase from £1.75m to £1.8m at the turn of the tax year. It will then be fixed at £1.8m until at least 2016 (unless reviewed by an incoming government).

As planned, individuals aged 50 that have opted for primary protection will have the allowable growth within their pension funds effectively capped for a period of 5 years.

By vesting the pension in full, the pension will not be subject to the LTA at a later date. The pension fund is not therefore restricted to any particular growth rate.

If further income is not required immediately, the income can be set at zero. And because the crystallisation of the pension triggered an ‘entitlement’ to pension benefits, the option for an income stream to commence before age 55 is retained.

What to do with the PCLS
On pension crystallisation, an individual can take a portion of their pension as a pension commencement lump sum (PCLS) or, as more commonly known, ’ tax free cash’. If there is not an immediate need for the capital, it can be reinvested outside the pension environment. If held in a taxable form, growth will be subject to capital gains tax (currently set at 18%) after the personal annual allowance of £10,100 has been used. This is a lower ‘effective tax rate’ on growth than experienced in a pension, 75% of which will effectively be subject to income tax at 40% or 50% for higher earners when extracted.

This presumes that the individual buys assets that attract capital gains. If on the other hand, index linked gilts (ILGs) were purchased the arrangement becomes even more tax efficient. ILGs are subject to minimal taxation when held directly (outside a tax wrapper). Most of the inflation compensation element of the return is in the form of tax-free capital uplift rather than taxed coupon uplift. This contrasts with nominal interest rates, where most of the rate paid is compensation for inflation and is then taxed as income, and with equity returns, where the inflation compensation is partly via income and partly gain, with both subject to taxation.

Capital Extraction / Income Drawdown
Extracting the full ‘economic value’ in a personal pension fund is extremely difficult and in many cases impossible. Therefore, once a decision has been made to extract the tax free cash, a plan to extract the maximum amount of pension capital is likely to follow.

Throughout ‘decumulation’, the period of time during which individuals enjoy the accumulated capital, pensions are overly restrictive. Once the tax free lump sum has been drawn, the annual income that can be drawn from the pension is restricted to rigid government actuarial department (GAD) tables, influenced by the yield on 15 year Gilts, and taxed at marginal rates of income tax.

The after-tax benefits of savings in or out of a pension wrapper can be measured by comparing net present values (the total present value of a time series of cash flows minus the initial investment) of the two cash streams after their different tax treatment. We find many people who have previously focused on the tax advantages of accumulation are shocked to discover how small the net present value gain from their pension is. However, even this calculation ignores the uncertainty about the amount of capital that can be enjoyed either as lifetime spending or as a bequest. This is a serious oversight as there is in practice a large degree of inefficiency in the extraction of value from a pension account under current tax rules, aggravated by the penal taxation of residual funds after the deaths of both member and spouse. The rules are also designed to ensure that there is likely to be a residue if the second death occurs after age 75. The intention of these rules may have been to make the option of drawing down after age 75 unappealing.

The risk of not extracting all of the value from the pension fund can be avoided by buying, at some stage, an annuity. The potential loss of early death is offset by an equivalent gain from outliving one’s actuarial expectancy. However, this calculation is not a satisfactory explanation of the benefit of capital in or out of pensions where there are children and a significant value is placed on a bequest motive. Such an approach to the economic value of pensions is clearly dependent on individual levels of wealth relative to spending.

A critical source of loss of economic value in pensions is inflexibility. Pension rules generally do not allow an individual to access pension capital should it be needed. This is highly relevant when a large proportion of the assets assigned to retirement spending takes the form of pension capital, in which case it may be impossible to meet unexpected exceptional expenditures.

Pension Winners
When considering the whole duration of a pension, from commencement of contributions to the pensioners demise, the tax benefits are very difficult to calculate. The only group that can be confident that they benefited from the pension tax structure, ahead of other alternatives, are individuals that made contributions to pensions as higher rate tax payers, and then drew down income as a basic rate (or lower) tax payer.

Pension Losers
High earners who were able to make very large contributions to personal pension arrangements and based their actions on the tax benefits going in are those most likely, depending on later circumstances, to have destroyed value.

Their number will be significantly increased if, as many now fear, the pension commencement lump sum of, typically 25%, is axed by a future government desperate for tax revenues. We believe this fear is exaggerated because it would render savings in a pension fund economically irrational even for the majority of savers. But this concern has been described to us by one of our clients as a ‘monster under the bed’ which, once it had entered his mind, could not be ignored, and could only be assuaged by crystallising his pension to be certain of not losing out.

Potential for conflict?
You may now be wondering, why you have not been advised to consume capital or crystallise pensions early by other advisers?

It could be that that they have placed too great a value on the benefit of income tax deferral and gross roll up (less the 10% tax credit), ignoring the real (after inflation) value that can actually be extracted from the pension fund.

It could be that they enjoy the dependency that is created by using the complicated legislation and tax structure of pensions?

Or it could be that the majority of advisers are remunerated by the value of assets within the pension fund.
In practice these may play a part, but the most significant reason is that most advisers do not have the necessary investment expertise to manage what is, an extremely difficult investment challenge. On this basis they will be reluctant to advise, and will almost certainly refrain from drawing on your pension early, regardless of the level of assets an individual holds elsewhere. They may also advise clients to draw more conservatively from the pension than is sustainable so to avoid depletion of the fund.

Planning from a holistic perspective
Putting aside the previous considerations, the decision to crystallise pension benefits should really be made within the context of establishing a sustainable level of lifetime spending that a total portfolio can support. Most pensioners are likely to value higher spending when fit and active, with income tapering down later in life. They are also likely to prefer passing surplus wealth to beneficiaries by the method of regular gifting from income. Not only is it efficient with regards to inheritance tax but the client also values the gifting with ‘warm hands’.

This type of spending plan is likely to be funded not just by pension funds but various financial assets both in and out of tax wrappers, as well (perhaps) as real property or contingent assets such as inheritance. Only by considering the balance sheet as a whole and the existing arrangements for holding assets can one make a fully-informed decision.

In a context of holistic resource planning , retirement spending funded by non-pension sources may run up against a cultural attitude that differentiates between income and capital, as in ‘not consuming the seed corn’. In a pension fund, of course, this distinction clearly does not need to mean anything significant. The ‘income’ drawn in retirement or taken as an annuity is actually a conversion of accumulated ‘capital’ to a stream of cash flows. The ‘capital’ accumulated is itself the product of savings out of earned ‘income’. It is just money.

The important output of planning is how money is consumed. Freeing up attitudes about where the money should come from will also allow greater tax efficiency, as the tax code penalises income relative to capital. Consuming capital is a way of reducing one’s overall effective tax rate but this is only likely to be acted upon if there is confidence in the solution managing the sustainable level of income.

The underlying economic principle of a holistic approach is total capital efficiency, where after-tax outcomes are measured against the particular way in which clients expect to derive benefits from their wealth. This is the essence of outcomes-based investment, organised to deliver both client- and goal-specific planned outcomes.

For those considering drawing (crystallising) their pensions, this Insight sets out essential information that will ensure they are certain i) that they understand how to make best use of the protection that has been put in place and ii) whether they fit into a group that may be able to draw a greater proportion of their pension fund as tax free cash than they had previously expected.

Enhanced versus Primary Protection
When applying for pension protection, enhanced protection was described by some as ‘total’ or ‘complete’ protection as it allowed an individual’s pension fund to grow to any size without facing a possible tax charge. And assuming that no further contributions to pension plans were made, this form of protection was the more heavily subscribed.

Far from offering unlimited growth, Primary Protection only protected the value of the pension fund in line with the predetermined statutory allowable growth rates. However, in light of recent stock market performance and with it the likely reduction in pension values, it is the manner in which the chosen protection calculates the tax free cash (TFC), rather than the protection’s allowable growth rules, that will determine which form of protection maximises the benefits under the ‘pension simplification’ rules.

Formula for tax free cash when protection is in place:

Key:

A-Day: 5th April 2006
SLA: Standard Lifetime Allowance
TFC: Tax Free Cash
PV: Pension Value

Example:
Mr Hanks’ pension fund was valued on A-Day at £4m, £1m (25%) of which was available as tax free cash. He ceased working in 2008 and wants to crystallise the pension in the current tax year, the SLA for which is £1.75m. Due to the drop in financial markets, Mr Hanks’s pension fund is now valued at only £3m. He has ‘enhanced (dormant primary)’ protection in place and he wants to know which protection option will offer him the largest lump sum.

Despite a drop in the pension value, the protected lump sum with primary protection has increased in line with the standard lifetime allowance, from £1m at A-day to the higher value of £1.167m.

Capital Extraction from Pensions
You may feel that in the above case, Mr Hanks should avoid drawing the tax free cash from his pension until markets recover. We disagree. Extracting the full value from pensions is extremely difficult and in many cases impossible. Therefore, once a decision has been made to extract the tax free cash, a plan to extract the maximum amount of pension capital should then logically follow.

Most individuals enjoy the advantage of pensions in reducing an annual income tax liability and investing funds in a tax wrapper that allows capital growth almost free of tax. For the period of ‘accumulation’, pensions remain an attractive option, particularly for higher rate tax payers. However for ‘decumulation’, the period of time during which individuals enjoy the accumulated capital, pensions are less attractive. Once the tax free lump sum has been drawn, the annual income is restricted to rigid government actuarial department (GAD) tables, influenced by the yield on 15 year Gilts, and taxed at marginal rates of income tax.

The after-tax benefits of savings in or out of a pension wrapper can be measured by comparing net present values of the two cash stream after their different tax treatment. We find many people who have previously focused on the tax advantages of accumulation are shocked to discover how small is the net present value gain from pensions. However, even this calculation ignores the uncertainty about the amount of capital that can be enjoyed either as lifetime spending or as a bequest. This is a serious oversight as there is in practice a large degree of inefficiency in the extraction of value from a pension account under current tax rules, aggravated by the penal taxation of residual funds after the deaths of both member and spouse. The rules are also designed to ensure that there is likely to be a residue if the second death occurs after age 75. The intention of these rules may have been to make the option of drawing down after age 75 unappealing. The effects of these rules can be mitigated by selecting a personal pension from age 75 that operates under occupational scheme rules rather than personal pension rules.

In practice, the risk of not extracting full value from the pension fund can be avoided by buying an annuity at some stage, as the potential loss of early death is offset by an equivalent gain from outliving one’s actuarial expectancy. However, this calculation is not a satisfactory explanation of the welfare benefit of capital in our out of pensions where there are children and a significant value is placed on a bequest motive.

A further general consideration is the flexibility of capital uses when access to it is constrained by pension rules. This is highly relevant when a large proportion of the assets assigned to retirement spending is in the form of pension capital. This effectively prevents one from meeting large unplanned capital payments, for whatever reason.

The actual mechanics of delivering a stable real income stream are also hampered by pension rules, as the monetary limits are reset on the basis of valuations of the assets no less frequently than every five years.

Finally, the pension rules may prevent one from ‘front-loading’ the income stream to reflect the typical time preferences of enjoying the funds whilst younger, fitter and healthier.

However, these flexibility factors fall away if vesting all segments immediately to maximise the tax free cash and then drawing the maximum allowable income each year thereafter.

These considerations are also somewhat specific to the assets held. When constructing and managing portfolios for known future income needs such as draw down, we use a technique similar to that of ‘liability driven investment’ (LDI) that is increasingly used in the institutional space by defined benefit occupational pension schemes. LDI involves a constant choice, within the context of an overall ‘risk budget’, between matching investments perfectly to a known future liability, or hedging, and bearing and managing risk in the form of holding investments with uncertain outcomes relative to the known liability.

Hedging requires a risk free asset that genuinely matches the cash flows of the liability and so makes the investor indifferent to the asset’s volatility. For individual retirees, this risk free asset is duration-matched index linked gilts.

These are very lightly taxed when held directly and outside a wrapper, as most of the inflation compensation element of the interest rate is added to the redemption value rather than to the coupon, and is untaxed. Contrast this with nominal interest rates, where most of the rate paid is inflation compensation and is then taxed as income, and with equity returns, where the inflation compensation is partly via income and partly gain, with both subject to taxation.

Anomalies of final salary (defined benefit) pension scheme:

1. Order of pension crystallisation

For those fortunate enough to have a final salary (also known as a defined benefit) pension scheme, a further complication may apply.

Upon crystallisation, some final salary pension schemes offer tax free cash lump sums that equates to less than 25% of the overall pension value. In this circumstance, only by vesting all personal pension benefits first, can one be certain of retaining the full level of tax free cash that had been secured at A-Day.

Example
Dr Healy has worked in the NHS and private sector building up two pension funds. His NHS pension is due to pay £70,000 p/a as income with a tax free lump sum of £210,000, overall this pension is valued at £1,610,000. He has also paid into a SIPP which has a value of £2m, from which 25% can be potentially drawn as a tax free lump sum. He is looking to vest both pensions in the current tax year, the SLA for which is £1.75m.

If Dr Healy draws from the NHS Pension first, (which we think is what most people in his position would do), he will be restricted to how much can be taken from the personal pension as tax free cash.

Percentage of standard lifetime allowance used upon crystallisation of his NHS pension
= (PV @ crystallisation / SLA @ crystallisation) * (100/1)
= (1.61m / 1.75m) * (100/1)
= 92% of the standard lifetime allowance used

Therefore, when Dr Healy comes to draw on this private pension of £2m he will be eligible to take only 8% of his personal pension fund (£160,000). This is the percentage of the lifetime allowance remaining and is significantly less tax free cash than the typical 25% (£500,000) that one would expect. The balance of the pension fund can be then be drawn, but as income that will be taxed at his highest marginal rate.

If no form of pension protection is in place, Dr Healy will face a significant lifetime charge of 55% on the funds valued in excess of the standard lifetime allowance. This would represent £1.023m.

If Dr Healy relied upon enhanced protection, no tax charge of 55% will be incurred, but significantly more tax will be incurred because of the reduced lump sum and therefore increased income tax charge.

If Dr Healy drew funds in the ‘wrong’ order, but had primary protection in place, he will not suffer. Primary protection, as mentioned earlier, locks in amount of tax free cash that can be drawn and will increase it in line with the SLA.
2. Commutation Rates and how to ‘beat the system

The commutation option, once described by the former Chancellor, Nigel Lawson, as ‘anomalous but much loved’ because the lump sum it pays is tax free, is available to almost all people who retire.

For defined benefit schemes, the lump sum generally operates on the basis that members can exchange part of their pension for a cash sum. Under simplification rules, and for those schemes that have chosen to implement it, the allowable limit increased in line with that of personal pensions to 25% of the deemed value of the overall pension fund.

However, the commutation rate is often seen as an opportunity by some pension schemes to reduce their overall costs and future liabilities, offering unattractive commutation rates. The NHS, for example, will increase the tax free lump sum by only £12 for each £1 of income surrendered. This is far from generous, and when assessed for the majority of individuals, proves deeply unattractive.

If, as in our earlier example, the value of the personal pension has dropped, Primary protection can be called upon to draw the protected level of tax free cash which, as a percentage of the overall fund value may be significantly higher than it had been, offering a further opportunity to extract capital from the pension tax wrapper.

Transitional protection is a complex area of pension planning that requires expert financial advice. Contrary to the political claims made for pension simplification, the complexity has increased the range of possible outcomes with good and bad decision making, which at least means the cost of taking the best possible advice can be justified. If this article has caused you to question your understanding, please feel free to make contact.