RPSM03105120 - Technical Pages: Protecting pension rights from tax charges: Lump sums: Valuing lump sum rights: Example 2

Valuing lump sum rights: example 2

Facts: Susan is a pre-1987 member of two retirement benefit schemes for the same employer. She has no pension rights or benefits except for these schemes. Her normal retirement age is 60.

On 5 April 2003 (her 50th birthday), she left employment and immediately took pension and lump sum benefits from Scheme 1. She had 30 years’ pensionable service and her pensionable earnings were £400,000. She took a lump sum of £400,000 on 5 April 2003, and on 5 April 2006 has a pension in payment of £80,000. On 5 April 2006, her rights under Scheme 2 remain deferred (uncrystallised).

Step 1: Calculate Susan’s crystallised and uncrystallised lump sum rights under paragraph 25 schedule 36 Finance Act 2004.

Susan’s crystallised rights from Scheme 1 are calculated as 25% of the value of her pension in payment on 5 April 2006. So they are 25% x £80,000 x 25, which is £500,000.

Susan’s uncrystallised rights under Scheme 2 are the greater of

• (3/80 x 30 (years) x £400,000 = £450,000) less the £400,000 paid from scheme 1 which gives £50,000, and
• (1.5 x £400,000 = £600,000) less the £400,000 paid from scheme 1 which gives £200,000.

The lump sum rights of £200,000 are calculated as at 5 April 2003, the date she took her benefits from Scheme 1. Her rights under Scheme 2 can therefore be increased in line with the increase in the RPI for the period of deferment (April 2003 to April 2006) giving, say, a 4% increase to £204,000.

The calculations are carried out on the basis that Susan is 60 on 5 April 2006 and that the actual lump sum paid from scheme 1 (£400,000) is the value of the aggregable benefit from scheme 1.

Step 2: Calculate Susan’s uncrystallised lump sum rights under paragraph 26 schedule 36 Finance Act 2004 (the HMRC limit test).

Her lump sum rights under Scheme 2 are the greater of

• 3/80 x 30 (years) x £400,000 = £450,000, and
• N/NS x LS. 30/40 x 1.5 x £400,000 = £450,000.

So her maximum lump sum on 5 April 2003 was £450,000. As she took £400,000 from Scheme 1 on that date, she has a deferred entitlement to a further lump sum of £50,000. This amount may be increased in line with the RPI increase (again assumed to be 4%) to £52,000 as at 5 April 2006.

The calculation at Step 2 use Susan’s actual age on 5 April 2003 and takes account of her aggregable benefits from Scheme 1. The value of the lump sum (£400,000) is the amount paid from Scheme 1, rather than the value deemed to be her crystallised lump sum rights (£500,000) at Step 1.

Step 3: Compare values for uncrystallised lump sum rights under steps 1 and 2 and adjust if required.

Susan’s uncrystallised rights under Step 1 were £204,000, and under Step 2 were £52,000. Susan’s rights must be taken as the value under Step 2.

Summary - Susan’s crystallised lump sum rights are £500,000 and her uncrystallised lump sum rights are £52,000 giving her total lump sum rights of £552,000.