HMRC acts to close tax-free cash loophole

HM Revenue and Customs have issued revised rules on stand-alone pension lump sums in an effort to ‘plug various loopholes'.

The new amendment order is designed to stop people from taking a pension commencement lump sum (PCLS), or tax-free cash, higher than the normal 25% limit which came into effect on A-Day without meeting certain requirements.

HMRC says the original order had to be revised “to ensure the rules for a stand-alone lump sum fit more easily with those for protected PCLS”. This is because there was a loophole for those individuals who before A-Day had the right to take all of their benefits in the form of a tax-free lump sum, or stand-alone lump sum.

Although A-Day has put in place a 25% limit for PCLS, people who had built up rights to tax-free lump sums higher than this have been able to protect their rights through primary, enhanced or scheme specific protection.

Providing a member entitled to a stand-alone lump sum qualifies for one of the protections and meets certain other conditions, the new order does not stop schemes from paying out stand-alone lump sums.

Instead, HMRC is trying to stop people from artificially increasing their benefits, and therefore their stand-alone lump sums, through transfers into relevant schemes, as under the original rules this would have allowed a higher lump sum payment.

But now the amendment, which comes into effect today instead of the usual 21 days delay to prevent forestalling, says the entitlement will only be retained after a transfer into a scheme if:

• The transfer comes from a scheme where immediately before the transfer the member had the right to the payment of a stand-alone lump sum,
• All of the member’s uncrystallised rights are transferred from the old scheme to the new one

Meanwhile transfers out of a scheme will only be eligible to keep the entitlement if:

• A transfer from a scheme where the member has a right to a stand-alone; lump sum goes into a scheme the member doesn’t already belong to;
• The transfer is a block transfer, and
• The receiving scheme does not already hold any funds relating to the member.

The guidance note also says for clarification transfers into a deferred annuity contract (Section 32) following the winding-up of a scheme also count as a block transfer and providing all other conditions are met, it can be allowed to pay out a stand-alone lump sum.

HMRC, which also limits the payments to those members between the age of 55 and 75, says “this order plugs various loopholes which could allow some individuals to take much larger tax-free lump sums than the legislation intends”.

It adds the amended order should now work “in the way the original Order was intended to work in line with announced policy, and will not therefore affect those paying lump sums in normal circumstances.”

Andrew Tully, marketing technical manager at Standard Life, says: “This continues to show the Finance Act has more holes than swiss cheese. A small number of advisers may have been aware of this loophole, but it wasn’t common knowledge. Advisers should take note of this change and expect more of a similar nature in due course.”

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