Techzone

The right scheme

The ability to transfer between registered pension schemes has always been an important feature of pensions, allowing members to move their pension savings for a variety of reasons - for example:

• pension consolidation to simplify their pensions
• to access different benefit options
• better or wider investment options
• lower charges
• unhappy with the level of service/administration

Legislatively, there are no age restrictions on when pensions can be transferred. But, in practice, some pension providers may have their own restrictions.

The 'pension freedoms' introduced in 2015 undeniably sparked a demand for transfers to modern contracts which can provide all the retirement and death benefit options.

The option of income drawdown can give the member greater flexibility and tax efficiency in how they take their pension savings. The changes in how death benefits are taxed and who can benefit mean that the option of beneficiary's drawdown gives the ability to pass pension wealth down through the generations - or even to friends. Achieving this means being in the right pension, with the right nominations, at the right time.

The introduction of the ‘lump sum death benefits allowance’ (LSDBA) following the removal of the lifetime allowance on 6 April 2024 further strengthens the case for being in the right scheme.

As the name suggests, the LSDBA only applies to lump sum payments. On death before age 75, lump sum death benefits paid in excess of the available LSDBA are subject to income tax at the beneficiary’s marginal rate. However, any death benefits paid as a pension are not tested. So, on death before age 75, beneficiaries who choose beneficiary's drawdown can draw as much as they want, when they want, tax free.

Being in a scheme with all the options still, of course, gives the member the option of choosing to buy an annuity if that best suits their needs - income drawdown won't be right for everyone.

Possible issues on transferring pensions

Before transferring, it's important to check if any benefits could be lost on transfer or if there could be any other consequences. That's not to say that the transfer shouldn't still go ahead if there is an issue; what's important is that the decision to transfer, or not, leads to the outcome that best suits the client's needs.

Transferring while in poor health - IHT

HMRC take the view that transferring pension benefits from one scheme to another is a transfer of value for IHT. This is regardless of whether the pension benefits in both the original and the new scheme are outside the estate for IHT.

This will only potentially be an issue if the client was in poor health at the time of transfer. A Court of Appeal decision in the ‘Staveley Case’ has called into question HMRCs approach to transfers in ill-health.

HMRC haven’t updated their guidance following the decision which leaves an amount of uncertainty on the IHT position on transfers where a client suspects they may not survive for more than two years from the date of transfer.

To avoid this uncertainty, it makes sense for any client considering a pension transfer to act before their health starts to decline.

From April 2027, most pension death benefits will be included in an individual’s estate for inheritance tax purposes. However, dependants’ scheme pensions and charity lump sum death benefits to a qualifying charity will not be included and benefits paid to a spouse or civil partner will qualify for the spousal exemption.

Although the legislation is not yet in force, this could impact how individuals make decisions regarding their pensions going forward.

More details on pension transfers and IHT are contained in our technical guide Pensions and IHT.

Transfers involving protected tax-free cash or a low pension age

There's an additional complication when transferring benefits which have:

• an entitlement to more than 25% tax-free cash under 'scheme-specific tax-free lump sum' protection or
• a protected low pension age

Unless the transfer is part of a 'block transfer', the protection will normally be lost. However, protection can sometimes also remain on certain individual transfers or on scheme wind-up:

• Block transfers: A transfer is a 'block transfer' if two or more members of a pension scheme transfer to the same receiving scheme at the same time. There's no requirement for all members involved to have something to protect.
  
  The transfer must represent the members' total rights under the transferring scheme and can't be split across more than one receiving scheme.
  
  If any member involved in a block transfer has been a member of the receiving scheme for more than 12 months when the transfer is made, their transitional protection will normally* be lost - this includes all previous periods of membership of the scheme, even if the benefits have since been transferred out. But the block transfer will still be effective for the other member(s).
  
  * The 12 month rule does not apply to those with a protected low pension age of 55 or 56.
• Scheme wind-up: A protected tax-free cash entitlement or low pension age can also be maintained where a scheme is being wound-up, as long as the trustees either:
  
  
  • transfer the member's total rights to a single deferred annuity contract (or buy-out contract) or
  • assign the members rights under the scheme into an individual policy directly for the member
• Individual transfers: The normal minimum pension age will increase from 55 to 57 on 6 April 2028. Some individuals will have a protected low pension age of 55 or 56. This protection is not lost on transfer, even if it’s not a block transfer.
  
  For transfers which are not block transfers, the receiving scheme must ringfence the benefits with the protected pension age. So, any future contributions or transfers to the receiving scheme, or any funds that it held prior to the individual transfer, won’t have the protected pension age. There will be a part of the scheme that will be able to be accessed at age 55 or 56, and a part that will be subject to the normal minimum pension age of 57.

Of course, losing the protection may not be much of a concern if the level of tax-free cash is only marginally greater than 25%, or if benefits are unlikely to be taken before the normal minimum pension age - or perhaps if the benefits gained from transferring outweigh the loss of protection.

Some clients with protected tax-free cash will be in schemes that can't facilitate drawdown and they may not have a transfer 'buddy' to allow a block transfer.

To help members in this position, some pension providers have amended their scheme rules to notionally allow drawdown. This allows the member to take the protected tax-free cash and go into drawdown at the minimum rate of £0. Then a 'drawdown to drawdown' transfer can be made to a scheme which can fully facilitate drawdown. These transfers are sometimes referred to as 'unsecured transfers'.

This solution gives the best of both worlds for those who are old enough and ready to take their tax-free cash.

Extra care is needed when consolidating pensions where more than one of the schemes has protected tax-free cash - this can result in a lower overall tax-free cash entitlement. More information on this is available in our practical guide Consolidating pensions.

Our guides Scheme specific tax-free cash protection and Pension age give more information on these protections.

Giving up guarantees or other benefits

Particularly with older schemes, care is needed to check if any valuable investment or annuity rate guarantees could be lost. For example:

• Guaranteed annuity rates can result in a significantly higher retirement income. However, these sometimes apply only at a certain age and on a prescribed basis
• With-profit funds could have investment guarantees or a potential terminal bonus. Watch out also for the possibility of a market value adjustment (MVA) or other exit penalties on transfer

Workplace schemes

Clients looking to transfer benefits from their employer's pension workplace scheme should check if membership and, perhaps more importantly, ongoing employer funding would stop. A partial transfer could be the answer if this is a problem.

Workplace pensions can sometimes have associated death-in-service cover which could be lost if the pension funds are transferred.

Transferring 'safeguarded benefits' and advice
Safeguarded benefits are any benefits which include some form of guarantee or promise about the rate of secure pension income that the member or their beneficiaries will receive (or will have an option to receive).

To make sure individuals are fully aware of what they could be giving up, they must get 'appropriate independent advice' from an FCA authorised adviser before transferring - unless the value of the safeguarded benefits in the scheme is £30,000 or less.

For more information, see the 'Safeguarded benefits and the advice requirement' section in our technical guide Pension Transfers - DB to DC.

Pension scams prevention

Regulations have been introduced to help protect members from pension scammers. They allow pension trustees and scheme managers to refuse transfers where there's a suspicion of scam activity. When processing transfers, they’re encouraged to pass through several steps of due diligence, which includes flagging potential problem transfers as either ‘amber’ or ‘red’ flags.

• If the transferring scheme raises a red flag, the transfer can be stopped
• If an amber flag is raised, the member will have to take specific scam guidance from the Money and Pensions Service (MaPS) before the transfer can go ahead

The following types of scheme are deemed to be ‘safe destinations’ and are effectively exempt from these new rules:

• public sector schemes
• authorised master trusts schemes
• authorised collective DC schemes

Drawdown transfers

Drawdown funds can be transferred. This doesn't just apply to the original member - beneficiaries can also transfer drawdown funds that they've inherited.

However, it's not possible to partially transfer drawdown funds under an arrangement - all drawdown funds under the arrangement must be transferred. If there are multiple drawdown arrangements under a scheme, they don't all have to be transferred. Each arrangement can be considered independently.

Funds in capped drawdown can be transferred and remain in capped drawdown in the receiving scheme.

For more information on drawdown transfers, see our technical guide Income drawdown.

Partial transfers

Pension schemes can make partial transfers to other pension schemes - but this may depend on the scheme rules allowing it.

But there are two special situations to be aware of:

• Mixed benefit schemes - Members have a statutory right to transfer a category of benefit, while leaving other benefits behind. For example, transferring only the defined contribution part and leaving the defined benefits behind, or vice versa.
• Drawdown funds - It's not possible to partially transfer drawdown funds under an arrangement. All drawdown funds under the arrangement must be transferred. But if there are multiple drawdown arrangements under a scheme, they don't all have to be transferred.

In-specie pension transfers

The usual way of making pension transfers is for the investments under the transferring scheme to be encashed and then transferred to the receiving scheme.

Sometimes an alternative to the traditional cash transfer is an in-specie transfer - where assets are transferred directly from one pension scheme to the other. This means that legal ownership of the assets themselves is transferred from the transferring scheme to the receiving scheme. This can reduce transaction costs by removing the need to sell investments and then buy new ones.

This approach is particularly well suited to SSAS or SIPP directly invested in assets such as property or company shares. But in-specie transfers can also be used for transfers between insured pension schemes, to avoid incurring surrender penalties or losing future bonuses on insurance policies.

In-specie transfers can be an attractive option when:

• there's a desire to keep a specific asset (e.g. the company's trading premises or an existing share portfolio)
• it's not in the member's best interests to sell an investment at the time of transfer (e.g. share based investments during a market depression or insurance policies with early surrender penalties or future bonuses) or
• an asset is difficult to sell to finance a cash transfer payment in the required timescale (e.g. land or property investments)

In-specie transfers are particularly attractive where commercial property is involved as it normally avoids having to pay stamp duty land tax. Of course, there could be other legal or administrative costs.

But it's not a given that an in-specie transfer will be an option. Some pension schemes can't, or simply won't, accept some types of asset. In all cases, it's best to check at an early stage that the administrator of the receiving pension scheme is willing, in principle, to accept the proposed in-specie transfer of assets.