RPSM03104590 - Technical Pages: Protecting pension rights from tax charges: Enhanced protection: Relevant benefit accrual: Example

Relevant benefit accrual in defined benefits and cash balance arrangements: example

David is a member of a contracted-out defined benefits arrangement with an accrual rate of one sixtieth for each year of service. On 5 April 2006, David has 30 years’ service and his pensionable earnings are £120,000. He takes benefits in April 2011. The arrangement uses the 20:1 valuation factor in s276 FA 2004.

Step 1

On 5 April 2006, David’s rights are valued at £1.2 million (30/60 x £120,000 x20).

Step 2

Calculate the ‘appropriate limit’ using the value from Step 1. Two calculations need to be done: the higher of the two is the “appropriate limit”.

The first calculation is increasing £1.2 million by an indexation figure. The indexation figure is the highest figure obtained from a calculation over the period between 6 April 2006 and the date of the relevant event. The indexation figure is the highest of

• 5% annual compound interest over the period,
• [RPI(2) – RPI(1)] / RPI(1)

where RPI(2) is the RPI for the month in which the first relevant event occurs and RPI(1) is the RPI for April 2006; or

• for contracted-out rights, the percentage rate specified in The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 – SI 2006/130.

Assume the highest figure is arrived at by using 5% compound for the five years between April 2006 and April 2011. Indexing £1.2 million in this way gives a figure of £1,531,538.

The second calculation is to use David’s pensionable earnings in April 2011 and apply David’s accrual rate under the arrangement to this. In this instance, the scheme rules would not apply an early retirement factor to David’s pension rights when they come into payment in 2011. David’s pensionable earnings are now £160,000. Assume that this pensionable earnings figure does not exceed the limit on post-commencement earnings. David’s pre 6 April 2006 rights have a value of £1.6 million (30/60 x £160,000 x 20).

The amount of £1.6 million from the earnings re-calculation is higher than £1,531,400 figure from the indexation calculation. So the appropriate limit is £1.6 million.

Step 3

Compare the value of the benefit crystallisation event in April 2011 with the appropriate limit.

Scenario 1: The benefit crystallisation event in April 2011 is worth £1.75 million. Enhanced protection is lost but there is no lifetime allowance charge because the standard lifetime allowance is £1.8 million.

Scenario 2: The benefit crystallisation event in April 2011 is worth £2 million. Enhanced protection is lost and there is a lifetime allowance charge.