RPSM09100350 - Technical Pages: Member benefits: Overview: Authorised benefits: Level of pension commencement lump sum

Level of pension commencement lump sum payable to the member

The size of the maximum tax-free lump sum payable is capped by reference to the capital value of the total pension benefit crystallising, that is, the lump sum plus the residual

• scheme pension,
• lifetime annuity, or
• income withdrawal (an unsecured pension).

The basic rule is that 25% of the total capital value of the lump sum and the scheme pension/lifetime annuity/unsecured pension it is being paid in connection with may be paid as a pension commencement lump sum. Given that the three pension benefit types operate differently, the legislation specifies how the maximum tax-free lump sum is calculated in each of the three scenarios.

With a money purchase arrangement, as there is a distinct pot of money to provide both the lump sum and lifetime annuity/unsecured pension benefit, the maximum tax-free lump sum is one third of either the annuity purchase price or the funds that have been crystallised to provide an unsecured pension (i.e. the unsecured pension fund).

Where a lump sum is being paid in connection with a scheme pension the calculation is a little more complicated (as there is not necessarily a fund as such, simply an entitlement to a certain level of pension). Here the 25% calculation is applied to the capital value of the amounts crystallised from both lump sum and pension for lifetime allowance purposes.

The lump sum may be paid up to 6 months before (or 12 months after) entitlement to the related pension arises. If the lump sum is paid early in this way and the member then dies before entitlement to the related pension actually arises, entitlement to the lump sum is deemed to have arisen immediately before they died. The amount of lump sum paid must have been within the member’s available lump sum allowance at the point of entitlement to the lump sum.

The 25% figure will be reduced

• where the standard lifetime allowance threshold is reached at the point that benefit entitlement arises (so the individual’s total tax-free lump sum payments are effectively capped at 25% of the standard lifetime allowance), and
• in certain circumstances where the arising entitlements consist of pension credit rights (called disqualifying pension credit) – see RPSM09104240.

A higher fraction or percentage may be paid where an existing lump sum entitlement held at 5 April 2006 has been protected through transitional protection – see RPSM03105500.

The maximum amount that may be treated for tax purposes as a pension commencement lump sum under an arrangement is referred to as the permitted maximum.

This is explained in more detail in RPSM09104100 to RPSM09104560.

If a scheme pays a member a higher lump sum any excess over the permitted level will not be a pension commencement lump sum. RPSM09104030 explains how the excess payment would be treated and taxed.