DIRECTORS’ PENSIONS - 23.02.2011

Don’t lose your pension payout

Pension experts often encourage diverse pension investments. But chopping and changing pension schemes might result in the cash lump sum you’re entitled to being slashed. What steps can you take to avoid this calamity?

More than one fund

“Don’t keep all your eggs in one basket”. How often have you heard or read that advice when it comes to investments? We wouldn’t argue against it but if you’re a director who has investments in more than one pension fund, there’s another adage you need to keep in mind; “look before you leap”. Switching an existing pension scheme might cost you dear in the long run.

Directors are unintentional targets

The rules for pension commencement lump sums (PCLSs), often called “tax-free cash”, can be tricky, especially for Executive Pension Plans (EPPs), Small Self-Administered Pension Schemes (SSASs) or Section 32 policies (s.32s). These schemes can offer advantages for directors compared to a Personal Pension Scheme (PPS) and so are often the preferred choice. But they can have higher admin etc. charges, meaning that you may be tempted to switch to a cheaper PPS or similar.

Greater payouts

While there may be cost savings for pension schemes started after April 5 2006, these offer a PCLS of only 25% of the fund value. But the three different schemes mentioned above can offer you a much greater PCLS, possibly up to 100% of what the fund was worth in April 2006, plus any corresponding growth since then. This higher PCLS is protected against future changes in the pension rules which would otherwise reduce it.

Trap. Where you transfer funds from a scheme with a protected PCLS, of say, 100% of the April 2006 fund value to a new scheme, the protection is lost. The PCLS will be slashed to 25% of the new fund value. But the trouble doesn’t end there.

Spreading the PCLS

The rules are more tricky where you have two or more funds which have protected PCLSs.

Example - the 50/50 rule. Bob is a director and has two EPPs; one is worth £120,000, the other £80,000. The schemes’ managers calculate that the total PCLS Bob could have is £70,000. Because either scheme could afford to pay the full PCLS, the rules simply say that the total is split between the two, i.e. £35,000 each. That’s 29.16% of the first scheme but 43.75% of the second. So on the face of it Bob would be mad to transfer the second scheme into a new pension, but it might be worth transferring the first as the admin cost savings could outweigh the relatively modest loss of the PCLS.

Trap. Where you belong to two or more schemes with protected PCLSs and, unlike the example above, one can’t affordtopaythe full amount, an even trickier rule applies for calculating how much PCLS each scheme can pay (see The next step).

Tip. Look before you leap!Before transferringa pre-April 2006 EPP, SSAS or S32 pension scheme, say to save on admin fees, find out how much PCLS you’re entitled to so that you can avoid throwing it away. This isn’t a DIY project; we recommend you use your financial advisor.

For another example of how the PCLS rules work, visit http://companydirector.indicator.co.uk (CD 12.10.07).

Some pre-April 6 2006 company pension schemes include the right to a protected tax-free lump sum well above the 25% offered by new schemes. But the protection can be lost if you transfer the fund. Before switching pension schemes ask your financial advisor to check that you won’t lose out on a lump sum payment.

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