PTM063240 - Member benefits: lump sums: Pension commencement lump sum (PCLS): applicable amount
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Glossary PTM000001
听
The applicable amount
The applicable amount when the member becomes entitled to a drawdown pension
The applicable amount when purchasing a lifetime annuity contract
The applicable amount when purchasing a joint lifetime annuity or deferred annuity contract from uncrystallised funds
The applicable amount for an arising entitlement to a scheme pension under a money purchase arrangement
The applicable amount for an arising entitlement to a scheme pension under a defined benefits arrangement
Where part of the defined benefits听scheme pension entitlement is commuted to provide the lump sum
Abatement of a scheme pension under a public service pension scheme
Anti-avoidance measures on transfer
Anti-avoidance measures on surrender
The applicable amount
Paragraph 2A schedule 29 Finance Act 2004
The basic rule is that 25% of the total value of the pension and听lump sum entitlements arising at a particular time in an arrangement or arrangements under a registered pension scheme may be paid as a pension commencement lump sum, provided these entitlements do not fall into certain excluded categories.
The payment may be made up to 6 months before and 12 months after the member becomes entitled to the lump sum. However, it will only become a pension commencement lump sum and therefore an authorised payment when the entitlement arises. For the purposes of valuation against the lump sum allowance and lump sum and death benefit allowance the amount crystallised by the pension commencement lump sum is the amount which was paid. The full value of the pension commencement lump sum will be deducted from the member's lump sum allowance and lump sum and death benefit allowance. The maximum level of pension commencement lump sum payable is capped by reference to the capital value of the pension benefit (or benefits) the lump sum is linked to. The lump sum must be linked to one or more arising entitlements to:
- income withdrawal (drawdown pension) - see from PTM062700
- a lifetime annuity (see PTM062400)
- a scheme pension (see PTM062300).
The calculation is referred to in the legislation as the applicable amount.
As the three types of relevant pension entitlement are different in nature the legislation sets out how the applicable amount should be calculated for each type.
For example, with a scheme pension, there is no earmarked fund value to which the calculation can be linked. So, the method of calculating the applicable amount is very different from the other two methods of calculation.
Where the lump sum is being paid from a different arrangement to that in which the entitlement to the relevant pension has arisen (whether in whole or in part), when calculating the applicable amount, account should be taken of any other pension commencement lump sum being paid from the same arrangement as the relevant pension that is linked to that pension entitlement.
The applicable amount when the member becomes entitled to a drawdown pension
Paragraph 2A Schedule 29 Finance Act 2004
The applicable amount where uncrystallised funds are being designated to provide drawdown pension under a money purchase arrangement, that is not a collective money purchase arrangement,听is:
one-third of the total of:
- the sums designated as being available for the payment of drawdown pension on that occasion under that arrangement
- the market value of the assets similarly being designated (taking into account any liabilities associated with that asset, such as a mortgage) under that arrangement
minus any of the sums and assets that represent rights attributable to a disqualifying pension credit (PTM063230) under that arrangement.
The legislation sets a limit of a 鈥榯hird鈥� as the applicable amount is measured against the amount being designated for drawdown. One-third of the amount designated for drawdown should equal 25% of the amount designated for drawdown plus the lump sum.
Any funds that are attributable to a disqualifying pension credit are deducted from the amount designated for drawdown, as explained in PTM062500 onwards.
Example 1
Amanda has uncrystallised funds held in a money purchase arrangement, that is not a collective money purchase arrangement,听of 拢400,000. Amanda wants to draw all her benefits, including the maximum lump sum permitted under the scheme rules of 拢100,000.
The funds that will be designated to provide drawdown pension total 拢300,000. There is no disqualifying pension credit. So, the applicable amount is 拢100,000 (a third of 拢300,000).
The听scheme administrator knows in her case the available portion of the member鈥檚 lump sum allowance will be higher than the applicable amount. So, as the lower of the two figures, the permitted maximum will be the 拢100,000 applicable amount.
The scheme pays Amanda the 拢100,000 pension commencement lump sum. The remaining 拢300,000 becomes a flexi-access drawdown fund under the arrangement.
Example 2
Mike has 拢400,000 uncrystallised funds held in a money purchase arrangement, that is not a collective money purchase arrangement, but 拢200,000 of these funds represent a disqualifying pension credit. Mike wants to take all his benefits under the arrangement, taking the maximum pension commencement lump sum possible with the remainder of the funds being used to generate a drawdown pension.
The scheme administrator must ignore the 拢200,000 disqualifying pension credit being designated to provide a drawdown pension when calculating the applicable amount.
The easiest way to work out the applicable amount is to take 25% of the uncrystallised funds that are not a disqualifying pension credit. 25% of 拢200,000 is 拢50,000.
Paying a 拢50,000 pension commencement lump sum leaves 拢350,000 to be designated to provide a drawdown pension. If the value of the disqualifying pension credit (拢200,000) is deducted from this figure and听the resulting figure (拢150,000) is divided by 3,听the result is听拢50,000. Mike鈥檚 lump sum is within the permitted maximum.
The applicable amount when purchasing a lifetime annuity contract
Paragraph 2B schedule 29 Finance Act 2004
The applicable amount when uncrystallised funds are used to purchase a lifetime annuity is one-third of the amount used to purchase the annuity contract under the arrangement or arrangements in question. This amount is referred to as the 鈥榓nnuity purchase price鈥�.
The legislation sets a limit of a 鈥榯hird鈥� as the applicable amount is measured against the residual funds left to purchase the annuity after the lump sum payment.
Any funds that are attributable to a disqualifying pension credit are deducted from the annuity purchase price, as explained in PTM063230.
Any sums or assets applied to the annuity purchase that have previously been designated to provide that member with a drawdown pension are also deducted from the annuity purchase price in calculating the applicable amount.听This is because the member has already had the opportunity to be paid a pension commencement lump sum in connection with those designated funds.听By deducting the amount of those previously designated funds from the annuity purchase price the legislation ensures that a pension commencement lump sum is paid only in respect of uncrystallised rights. This rule applies whether or not:
- a lump sum was actually paid when the funds were designated, or
- the funds originally designated were lower in value than the drawdown funds now being used to purchase the annuity.
Example 3 below shows how this deduction is applied in practice.
The applicable amount when an annuity is purchased from uncrystallised funds is therefore:
one-third of the total of:
- the cash sums applied to purchase the lifetime annuity and any related dependants鈥� or nominees' annuity
- the market value of any assets (property, shares policies and so on) that are also applied for this purpose (taking into account any liabilities associated with that asset, such as a mortgage)
minus:
- any of those sums or assets which have previously been designated as available for the payment of drawdown pension
- any of those sums or assets which are attributable to a disqualifying pension credit (see PTM063230).
The applicable amount when purchasing a joint lifetime annuity or deferred annuity contract from uncrystallised funds
Paragraph 2B(3), and (4)听schedule 29 Finance Act 2004
Section 278B Finance Act 2004
If a dependants鈥� or nominees' annuity provision is secured at the same time as the member purchases their own lifetime annuity, the total consideration paid for the annuities is included in the calculation of the applicable amount. This can be through the same contract (a joint-life annuity) or through a separate contract secured within 7 days before or 7 days after the lifetime annuity purchase. So, if 拢100,000 is used to buy a joint-life annuity the applicable amount will be the same as where 拢100,000 is used to purchase a lifetime annuity solely in relation to the member (with no provision for dependants or nominees).
The legislation refers to the provision of a dependants鈥� or nominees' annuity in the above circumstances as a 鈥榬elated annuity鈥� - see PTM072200.
Deferred annuity contracts
The purchase of an annuity contract that is not for the immediate provision of a lifetime annuity to the member will not give rise to a right to a pension commencement lump sum at the time of purchase. Such a right will only arise when benefits are first taken from the contract (when an actual entitlement to a pension arises).
Example 3
Tim has 拢350,000 of uncrystallised funds in a money purchase arrangement that is not a collective money purchase arrangement.
In June 2015, he draws benefits of 拢200,000 from his fund. He draws a 拢50,000 pension commencement lump sum and uses the rest to provide a drawdown pension. After the payment of the lump sum, Tim has uncrystallised funds of 拢150,000 and a flexi-access drawdown fund of 拢150,000 under the arrangement.
In March 2016, Tim鈥檚 uncrystallised funds stand at 拢160,000 (the additional 拢10,000 being attributable to investment growth and income) and his drawdown pension fund has reduced to 拢120,000. His total fund under the arrangement is therefore 拢280,000 at this point.
Tim decides to buy a lifetime annuity contract with all the 拢280,000 funds held in the arrangement, that is, with both his uncrystallised funds and drawdown pension fund.
For pension commencement lump sum purposes the 拢120,000 flexi-access drawdown fund used to purchase the annuity is excluded from the applicable amount calculation.
The easiest way to calculate the applicable amount is to simply take 25% of the uncrystallised funds. 25% of 拢160,000 is 拢40,000.
This tallies with the 鈥榦ne-third of the annuity purchase price鈥� calculation. Paying a 拢40,000 pension commencement lump sum leaves an annuity purchase price of 拢240,000. If the value of the drawdown pension fund (拢120,000) is deducted from this figure and听the resulting figure (拢120,000) is divided by 3,听the result is听拢40,000. Tim鈥檚 lump sum is within the permitted maximum.
If instead Tim had used all his funds under the arrangement to buy a joint-life annuity rather than a lifetime annuity, the applicable amount would be the same as above.
The applicable amount for an arising entitlement to a scheme pension under a money purchase arrangement
Paragraph 2D schedule 29 Finance Act 2004
Where the member becomes entitled to a scheme pension under a money purchase arrangement, that is not a collective money purchase arrangement, the applicable amount is one-third of 鈥榯he scheme pension purchase price鈥�.
鈥楾he scheme pension purchase price鈥� is the aggregate of:
- the amount of such of the sums held for the purposes of the pension scheme, and
- the market value of such of the assets held for the purpose of the pension scheme
as are applied in (or in connection with) the purchase or provision of the scheme pension and any 鈥榬elated dependants鈥� scheme pension鈥�
minus:
- any of those sums or assets which have previously been designated as available for the payment of drawdown pension
- any of those sums or assets which are attributable to a disqualifying pension credit (see PTM063230).
A dependants鈥� scheme pension is related to a scheme pension payable to a member of a registered pension scheme if:
- the day on which one is purchased, or sums or assets are applied for its provision, is no earlier than 7 days before, and no later than 7 days after, the day on which the other is purchased or sums or assets are applied for its provision, and
- the dependants鈥� scheme pension will be payable to a dependant of the member.
The applicable amount for an arising entitlement to a scheme pension under a defined benefits arrangement
Paragraph 2C schedule 29 Finance Act 2004
Where a scheme pension is provided under a defined benefits arrangement or a collective money purchase arrangement
The applicable amount is
(A + (B x C) - D) / 4
A= the amount of the lump sum to be paid
B= 20 (the relevant valuation factor as per Section 276 Finance Act 2004)
C= the amount of the pension which will be payable to the member in the 12 months beginning with the day the member becomes entitled to the pension
D= Deduction applied only where A or C represents rights where there is a disqualified credit
The formula also includes reference to the actual lump sum benefit paid, not just the residual pension benefit. So, for scheme pensions, the applicable amount is determined by taking one quarter of the value of the pension plus the lump sum. This is necessary because there may be no actual fund value, and only a notional capital value of a pension entitlement combined with an actual lump sum payment.
In some circumstances, the scheme will not have a set lump sum entitlement but will simply allow the permitted maximum pension commencement lump sum to be paid, and the entitlement to a lump sum may only be given at the expense of part of the scheme pension entitlement, that is, through commuting part of that pension entitlement to a given lump sum payment. Guidance on this is in the section听Where part of the defined benefits scheme pension entitlement is commuted to provide the lump sum below.
Example 4
Stephen has rights under a defined benefits arrangement. He draws benefits on his normal retirement date of 65 when he is entitled under the rules to a scheme pension of 拢10,000 per annum, and a lump sum of 拢40,000.
The scheme administrator calculates the amount that crystallises for lump sum allowance and lump sum and death benefit allowance purposes before actually paying benefits (so they can advise Stephen of this fact and seek confirmation from him that he has available allowance to cover the amount that will crystallise at the two RBCEs).
So, the applicable amount is 拢40,000 (the lump sum) plus 拢200,000 (the amount crystallising in respect of the scheme), divided by 4, which is 拢60,000.
Stephen confirms that he has available lump sum allowance and lump sum and death benefit allowance to cover the lump sum payments. So, assuming the lump sum meets all the other requirements, all of the lump sum to be paid represents a pension commencement lump sum and is paid tax-free.
Example 5
John has a 拢30,000 lump sum entitlement under a defined benefits arrangement and a 拢15,000 per annum scheme pension entitlement. No pension needs to be commuted to generate the lump sum entitlement.
One-third of his pension entitlement is derived from a disqualifying pension credit. So, 拢5,000 of his annual pension entitlement is excluded from the applicable amount calculation. This means only 拢10,000 of the scheme pension entitlement is included in the applicable amount calculation.
The maximum permitted pension commencement lump sum payable is 拢57,500. This is calculated as follows using the (A + (B x C) - D) / 4 formula.
A is 拢30,000
B x C is 20 x 拢10,000 = 拢200,000
A + (B x C) is 拢30,000 + 拢200,000 = 拢230,000
拢230,000/4 = 拢57,500.
So, the 拢30,000 entitlement is within the applicable amount margin.
Where part of the defined benefits scheme pension entitlement is commuted to provide the lump sum
Where part of the member鈥檚 scheme pension entitlement is given up to generate the lump sum payment, it is the actual post-commutation pension that is measured in 'C' (see above), not the potential crystallised value of the initial entitlement before commutation.
Where the commutation factor used by the scheme to calculate the level of pension given up in exchange for the lump sum payment is different from the relevant valuation factor used to calculate the crystallised value of the scheme pension, the resulting 鈥楢 + (B x C) - D鈥� figure is not easily identifiable in advance. This is because the lump sum (A) being generated by the commutation will not be the same as the crystallised value of the scheme pension being given up - therefore the additional 鈥楢鈥� generated will be different to the notional reduction in 鈥楥鈥�. So, the total of 鈥楢 + (B x C) - D鈥� will vary depending on the actual level of scheme pension being commuted.
As generally in these circumstances the scheme rules will simply allow for the payment of the maximum pension commencement lump sum permitted, the applicable amount will not be immediately apparent, as in order to calculate that amount, the听amount of the actual lump sum that is going to be paid needs to be known. Until听this is known, the actual reduced scheme pension entitlement听cannot be ascertained听(and so 'C' cannot be calculated).
The applicable amount may be calculated on the following basis, using the known factors of:
- the starting, pre-commutation annual rate of scheme pension, and
- the commutation factor being applied by the scheme.
The applicable amount can be ascertained by using the following equation:
20fg / (20 + 3f)
f = is the commutation factor being applied by the scheme.
g = gross scheme pension entitlement before commutation.
Where the applicable amount needs to be reduced due to a disqualifying pension credit a deduction needs to be made using 'D' in the formula. The required deduction means that the part of the pre-commutation pension that relates to the disqualifying pension credit becomes non-commutable.听In such a case a new variable (鈥榟鈥�) has to be factored into the formula so that it becomes:
20fgh / (20 + 3f)
f = the commutation factor being applied by the scheme.
g = the gross scheme pension entitlement before commutation.
h = the fraction of the scheme pension entitlement that is commutable.
Notes:
- the statutory formula, HMRC equation and the examples are based on the assumption that the only lump sum the scheme intends to pay is a pension commencement lump sum
- when using the equation there may be slight rounding differences compared to the result achieved using the A + (B x C) - D formula; these differences are acceptable to HMRC.
Example 6: the applicable amount where a scheme pension is commuted to provide a lump sum
A 拢50,000 per annum scheme pension entitlement where none of that pension is commuted to provide a lump sum gives an 鈥楤听x C鈥� value of 拢1 million (where using a relevant valuation factor of 20). So, 0 + (20 x 拢50,000).
Part of the scheme pension is commuted to provide a 拢200,000 lump sum, using a commutation factor of 15:1 (拢1 of annual pension is given up for every 拢15 of lump sum paid). The 鈥楢 + (B x C)鈥� calculation comes to only 拢933,340. This figure is arrived at as follows.
The 鈥楢鈥� value is 拢200,000.
The reduced scheme pension entitlement is now 拢36,667 (as, using the 15:1 commutation factor, 拢13,333 pension is commuted to provide the 拢200,000 lump sum).
So, 鈥楤 x C鈥� is 20 x 拢36,667 = 拢733,340.
So, using the formula A + (B x C) -听D the applicable amount is
(拢200,000 + 拢733,340)/ 4 = 拢233,335. So, the entire lump sum counts as a pension commencement lump sum (assuming no previous BCEs have occurred).
Example 7: the applicable amount where a scheme pension is commuted to provide a lump sum
The scheme pension entitlement before commutation is 拢30,000 per annum.
The commutation factor being applied is 15:1 (拢1 of annual pension is given up for every 拢15 of lump sum paid).
The maximum pension commencement lump sum that can be paid is 拢138,461.
This is calculated as follows using the equation:
20fg / (20 + 3f)
20 x 15 x 30,000 /divided by 20 + (3 x 15).
Or 拢9,000,000 /divided by 65.
The net pension after commutation will be 拢20,769 per annum (拢30,000 minus 拢138,461/15).
The net pension figure is then used in the (A + ( B x C)- D) /听4 formula.
鈥楢鈥�= 拢138,641
'B x C'= 拢415,380 (拢20,769 x 20).
鈥楢 + (B x C)鈥� = 拢553,841 (拢138,461 + 拢415,380).
A quarter of this听is 拢138,460.25.
This figure also represents a third of 鈥楤 x C鈥�, so we can see that the 鈥楢 + (B x C) - D/4鈥� formula is essentially achieving the same result as where dealing with a lifetime annuity or income withdrawal entitlement.
Example 8: the applicable amount where a scheme pension is commuted to provide a lump sum and the lump sum exceeds the permitted maximum
The member of a defined benefits arrangement in accordance with their scheme rules receives a scheme pension after commutation of 拢15,000 and a lump sum of 拢105,000 is paid in connection with the pension.
The scheme administrator realises that the lump sum may exceed the pension commencement lump sum permitted maximum. The lump sum satisfies the other conditions for being a pension commencement lump sum (see PTM063200).
A scheme can pay a lump sum in excess of the permitted maximum but if it does so any amount over the permitted maximum will not be a pension commencement lump sum (see PTM063230).
To decide how much of the lump sum can be paid as a pension commencement lump sum, the scheme administrator applies the听(A + (B x C) - D)/4 formula.
A is the 拢105,000 paid to the member.
C is the 拢15,000 scheme pension x B 20 = 拢300,000.
So, the applicable amount is (拢105,000 + 拢300,000)/4 = 拢101,250.
The scheme administrator establishes that the member had 拢100,000 available lump sum allowance at the time he took his benefits. As the applicable amount is lower than the available portion, the member鈥檚 permitted maximum is the applicable amount of 拢100,000.
The member was paid a lump sum of 拢105,000. The excess over the applicable amount (拢3,750) is not a pension commencement lump sum.听For the purposes of this example, if it cannot be paid as any other authorised lump sum payment,听it will be an unauthorised payment subject to the unauthorised payments tax charges (see PTM134100 for details of these charges).
Note: Had the trustees wished to avoid making an unauthorised payment and ensure the entire lump sum paid counted as pension commencement lump sum they would need to ensure that the lump sum paid to the member is no more than 25% of A + (B x C).
Example 9: the applicable amount where a scheme pension is commuted to provide a lump sum and there is a disqualifying pension credit
Stephanie has the right to be paid an annual scheme pension of 拢12,500 under a defined benefits arrangement. Half of Stephanie鈥檚 potential scheme pension represent a disqualifying pension credit.听Stephanie can commute part of her pension entitlement using a commutation factor of 16:1 to generate a pension commencement lump sum up to the permitted maximum.
Using the formula (20fgh / 20 + 3f) the scheme administrator calculates that the applicable amount is 拢29,412. This is based on:
f = the scheme commutation factor of 16
g = the scheme pension before commutation of 拢12,500
h = 0.5 (the fraction of the scheme pension entitlement that is commutable, that is, not a disqualifying pension credit).
So, 20 x 16 x 拢12,500 x 0.5 divided by 20 + (3 x 16) = 拢29,412.
It can be checked that this balances with the (A + (B x C) - D) /4听 formula as follows:
If a lump sum of 拢29,412, using the scheme commutation factor of 16:1, this generates a residual scheme pension of 拢10,661.75. The value of this (鈥楤 x C鈥�) is 拢213,235.
So, A + (B x C) before considering the element of disqualifying pension credit is 拢242,647 (拢29,412 + 拢213,235).
This figure is then discounted to reflect the crystallised value of the notional scheme pension entitlement that existed initially that represented a disqualifying pension credit, that is, the crystallised value of the 拢12,500 scheme pension that represents the disqualifying pension credit.
This can be represented by the following formula
A + ( B x C)- 20g(1 - h)
So, discounting 鈥楢 + (B x C)鈥� by 20 x 拢12,500 x 0.5 (1 - 0.5) = 拢125,000.
拢242,647 - 拢125,000 = 拢117,647. A quarter of this is 拢29,412.
Notes:
- the statutory formula, HMRC equation and the examples are based on the assumption that the only lump sum the scheme intends to pay is a pension commencement lump sum
- when using the equation there may be slight rounding differences compared to the result achieved using the (A + (B x C) -D)/4听 formula; these differences are acceptable to HMRC.
Abatement of a scheme pension under a public service pension scheme
Paragraph 9(1A) schedule 32 Finance Act 2004
Where a scheme pension being provided under a public service pension scheme is being abated, the level of that abatement is ignored when calculating the amount that crystallises for lifetime allowance purposes through BCE 2 as that pension entitlement arises (see PTM088620). The abatement has no effect on the maximum pension commencement lump sum payable.
Anti-avoidance measures on transfer
Paragraph 3B(3b) schedule 29 Finance Act 2004
Where sums or assets held for a money purchase arrangement are subject to a relevant transfer to another arrangement which provides defined benefit rights with the sole or main purpose of increasing the applicable amount when the member becomes entitled to a scheme pension, the scheme under which the 鈥榬elevant defined benefits arrangement鈥� is held is to be treated as making an unauthorised member payment.
The unauthorised member payment is calculated by finding the amount by which the applicable amount as calculated under the guidance on this page above (at The applicable amount for an arising entitlement to a scheme pension under a money purchase arrangement) exceeds the applicable amount as calculated under the other guidance on this page above (at The applicable amount for an arising entitlement to a scheme pension under a defined benefits arrangement).
Member money purchase funds are subject to a 鈥榬elevant transfer鈥� if they are transferred so as to become held for the purposes of, or to represent rights under, a defined benefits arrangement relating to the member under any other registered pension scheme.
鈥楻elevant defined benefits arrangement鈥� means either:
- the defined benefits scheme referred to in the preceding paragraph
- any other defined benefits arrangement relating to the member (under the pension scheme or any other registered pension scheme) in the case of which any of the sums or assets held for the purposes of, or representing accrued rights under, the arrangement directly or indirectly represent sums or assets previously held for the purposes of, or representing accrued rights under, the defined benefits arrangement so mentioned.
Anti-avoidance measures on surrender
Paragraph 3B schedule 29 Finance Act 2004
Where sums or assets held for a money purchase arrangement are surrendered in exchange for defined benefit rights with the sole or main purpose of increasing the applicable amount when the member becomes entitled to a scheme pension, the scheme under which the 鈥榬elevant defined benefits arrangement鈥� is held is to be treated as making an unauthorised member payment.
The unauthorised member payment is calculated by finding the amount by which the applicable amount as calculated under the guidance on this page above (at The applicable amount for an arising entitlement to a scheme pension under a money purchase arrangement) exceeds the applicable amount as calculated under the other guidance on this page above (at The applicable amount for an arising entitlement to a scheme pension under a defined benefits arrangement).
Member money purchase funds are subject to a 鈥榬elevant surrender鈥� if they are surrendered and, in consequence of the surrender there is a corresponding increase in the sums or assets held for the purposes of, or representing rights under, a defined benefits arrangement in the same scheme.
鈥楻elevant defined benefits arrangement鈥� means either:
- the defined benefits scheme referred to in the preceding paragraph
- any other defined benefits arrangement relating to the member (under the pension scheme or any other registered pension scheme) in the case of which any of the sums or assets held for the purposes of, or representing accrued rights under, the arrangement directly or indirectly represent sums or assets previously held for the purposes of, or representing accrued rights under, the defined benefits arrangement so mentioned.