PSI6.5.95 - Total Benefits On Retirement At Normal Retirement Age: Maximum Total Benefits – Pension Sharing on Divorce – Calculating Pension Debits in Defined Benefit Schemes

(This archived guidance relates to HMRC discretionary practice before the 6th April 2006. For current guidance on Registered Pension Schemes see the Registered Pension Schemes Manual)

When an employee retires and his or her benefit entitlement in the scheme is permanently reduced by a pension sharing on divorce order, section 31 of the Welfare Reform and Pensions Act 1999 requires the pension debit to be taken into account. In a defined benefit scheme this is done by

• calculating the amount of deferred pension that could have been provided to the employee from the percentage reduction in the cash equivalent transfer value required by the pension sharing order (see PSI6.5.87) – “hypothetical deferred pension equivalent of the pension debit”, then
• calculating what would have been the amount of the hypothetical deferred benefit at the employee’s normal retirement age – the pension debit or “negative deferred pension”, and then
• reducing the amount of benefit that could have been paid to the employee had there been no pension sharing by the amount of the pension debit or “negative deferred pension”.

Note the effects of a pension debit can be ignored for Revenue limits purposes where the employee is a moderate earner (see PSI6.5.90).

Example

Maximum approvable benefit for employee is 1/60th of final remuneration for each year of service

At time of divorce

Employee has 20 years membership and earns £30,000 a year

Accrued benefit is 20/60 x £30,000 = £10,000

Employee’s cash equivalent transfer value of accrued benefit is £100,000

Pension sharing order requires a 40% reduction in the cash equivalent transfer value = £40,000

(£40,000 is used to provide benefit rights or “pension credit” for the employee’s ex-spouse, see PSI24.1.1)

Reduction in employee’s cash equivalent transfer value would have provided a hypothetical deferred pension of £4,000 for the employee had the employee left pensionable service at the time of divorce

At employee’s retirement

Employee has 30 years service and final remuneration of £48,000

Maximum benefit entitlement had there been no pension sharing is 30/60 x £48,000 = £24,000

The hypothetical negative deferred pension calculated from the employee’s cash equivalent transfer value at the time of divorce of £4,000 has increased to £6,000 – this is because the scheme is required to revalue deferred pensions in line with statutory revaluation orders (for the purpose of this example only the statutory revaluation has been taken as 4.1% a year)

The employee’s actual maximum approvable pension is £24,000 - £6,000 = £18,000.