RPSM09104400 - Technical Pages: Member benefits: Lump sums: Pension commencement lump sum: Maximum amount: The applicable amount: Entitlement to a scheme pension under a defined benefit arrangement

The applicable amount for an arising entitlement to a scheme pension

Where a scheme pension is provided under a defined benefits arrangement there is no fund value. There is simply an entitlement to a given pension for life. As such it is necessary to attribute a notional capital value to that pension entitlement in order to apply the 25% measure in these circumstances. The scheme administrator has to do this for lifetime allowance purposes by multiplying the annual rate of scheme pension payable in that first 12 months by a relevant valuation factor of 20 (unless a higher factor has been agreed with HMRC).

The legislation simply takes that measure and applies it to the applicable amount calculation in this circumstance.

So the applicable amount in these circumstances is defined by the following formula

(LS + AC)/4

LS = the amount of the lump sum actually being paid.

AC = the amount crystallising for lifetime allowance purposes by reason of the member becoming entitled to the scheme pension (through benefit crystallisation event 2). RPSM11104220 to RPSM11104290 explain how this crystallised value is calculated.

The formula also includes reference to the actual lump sum benefit paid, not just the residual pension benefit. So unlike with the purchase of a lifetime annuity, where the applicable amount is one third of the purchase price, for scheme pensions the applicable amount is determined by taking one quarter of a larger measure (i.e. the value of the pension plus the lump sum). This is necessary because there may be no actual fund value here, and only a notional capital value of a pension entitlement combined with an actual lump sum payment.

Deductions are made from the ‘LS + AC’ formula in the same way, and for the same reasons, as where dealing with a lifetime annuity, namely where

• there is a disqualifying pension credit, and
• where the scheme pension is generated through the application of unsecured pension fund under a money purchase arrangement.

These deductions are discussed on RPSM09104460, with an example on RPSM09104480.

In some circumstances the scheme will not have a set lump sum entitlement but will simply allow the permitted maximum pension commencement lump sum to be paid. Here generally entitlement to a lump sum will only be given at the expense of part of the scheme pension entitlement; through commuting part of that pension entitlement in return for a given lump sum payment. The position here is discussed in RPSM09104430.