PSI8.2.2 - Lump Sum Benefits and Communication:
Commutation Factors - General
-
(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)
The relationship between the lump sum taken and pension
given up is commonly expressed as a commutation factor. Where a
scheme uses a commutation factor of 12:1 a member can have £12
cash for each £1 pension given up. We require this factor to
be used for members without continued rights in order to arrive at
the pension equivalent of the value of a lump sum retirement
benefit for the purpose of ensuring that total benefits do not
exceed Revenue limits. This applies regardless of the age or sex of
the scheme member or of the rate of escalation attaching to the
pension (see
PSI8.2.27et seq). For other purposes
schemes may use whatever cash option factors are considered
appropriate. The single (12:1) factor was introduced as part of the
simplification of practice changes announced in August 1991. It
does not apply to members with continued rights (unless the scheme
chooses to adopt it for all members regardless of the particular
regime which applies to them) and most of what follows in this
Section concerns these members, though the underlying general
principles remain the same for all. Continued rights members not
using the simplified factor of 12:1 must use a commutation factor
that is properly related to the capital value of their total
benefits. If it is too high insufficient pension is given up for
each £1 of lump sum paid, and this could lead to excessive
benefits. (Commutation factors should not be confused with annuity
rates which are used by Life Offices to calculate the amount of
annuity that can be bought for a given cash sum. More information
about annuity rates is given in
PSI20.3.4.)
Example Man aged 65, final remuneration
£12,000, maximum approvable pension is £8,000, maximum
allowable lump sum is £18,000. The commutation factor applied
for him by his scheme is 9:1, and this, as explained in
PSI8.2.12(a), is acceptable.
- Pension to be given up is £18,000/9 =
£2,000
Benefits are thus a lump sum of £18,000 and a residual
pension of £6,000.
- If a factor of 10:1 was used the pension to
be given up would be £18,000/10 = £1,800.
Residual pension will then be £6,200. But, as explained
later, 10:1 is not regarded as acceptable in these circumstances.
We take the view that the total pension consists of £6,200
plus an amount given up of £2,000 as in a. above. The
excessive factor has thus caused the total benefit of £8,200
to exceed the maximum approvable figure of £8,000.
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