RPSM11102055 - Technical Pages: Lifetime allowance: When you test for the lifetime allowance: What does “becoming entitled” to a lump sum mean?

What is meant by “becoming entitled” to a lump sum?

[s166(2), s216, paras 1-3A Sch 29] [The Taxation of Pension Schemes (Transitional Provisions)(Amendment)Order 2009-SI 2009/1172]

Pension commencement lump sum

BCE 6 occurs when the entitlement to the pension commencement lump sum arises. The lifetime allowance test is carried out using the lifetime allowance at that point of entitlement, so it is important to understand when that point arises.

For a pension commencement lump sum, the entitlement is normally deemed to arise immediately before the entitlement to the linked scheme pension / unsecured pension / lifetime annuity (see RPSM11102050), so that the two BCEs will always be linked. This date may well be different from the date that the lump sum was actually paid, as the lump sum can be paid up to 6 months before or 12 months after the entitlement to it arises.

Where the lump sum is a scheme specific protected pension commencement lump that is linked to a small pension right, and that pension right is in turn paid out as a trivial lump sum (as described at RPSM03105516), the entitlement to the scheme specific protected pension commencement lump is deemed to arise immediately before the entitlement to the linked trivial lump sum arises.

There are however special rules about the date of entitlement, which apply where a lump sum has been paid in anticipation of entitlement to any of the above kinds of pension arising within the following 6 months, but the member dies before that entitlement actually arises. In such circumstances, the payment may nonetheless be treated as a pension commencement lump sum and entitlement to the lump sum is deemed to have arisen immediately before the member’s death. The lifetime allowance test would then be carried out using the lifetime allowance at that time. The entitlement to the amount of lump sum arising immediately before the member’s death is regarded as using-up lifetime allowance before the deemed occurrence of BCE7s arising from the payment of lump sum death benefits - see RPSM11104820.

Overpaid pension commencement lump sums

[Regulations 17 & 18 of the Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171]

Where the amount of a pension commencement lump sum is overpaid in ‘good faith’, within the narrow circumstances outlined in RPSM09108040, the amount that has been overpaid will typically sit alongside the correct portion of the total lump sum provided. That correct portion is a normal pension commencement lump sum, entitlement to it arises in the normal way, as explained above, and it is subject to BCE 6 - again in the normal way as explained above.

However, the overpaid portion of the lump sum (the amount above the permitted maximum) is not strictly a pension commencement lump sum: rather it is a lump sum paid in error. Assuming it meets the narrow circumstances of the above regulations, the amount of the lump sum paid in error establishes an amount crystallised under BCE 9. Normally one must determine the time at which entitlement to any lump sum arises, in order to determine when to value the crystallising payment. In this case however, even though BCE 9 is calculated according to the amount of the overpayment, and strictly under the tax rules that overpayment is a separate lump sum, the regulations anchor its crystallisation to the member becoming entitled to ‘the other lump sum’, namely to the correct portion - the underlying pension commencement lump sum (which is itself valued for the BCE 6 mentioned above). This merging of the two lump sums for timing purposes makes sense if you consider the scheme only ever intended to pay one lump sum all along.

So the correct portion of pension commencement lump sum provides the point of entitlement which is used to determine when both portions of the lump sum crystallise under their respective BCEs (6 and 9). In this way, the two BCEs (6 and 9) are said to arise simultaneously, but have different values according to the two different elements of the lump sum provided.

Example

A scheme administrator calculated that Annaliese had an entitlement to a commuted pension commencement lump sum of £80,318, leaving a residual scheme pension of £12,047. Annaliese received these benefits, but the scheme administrator later realised that, owing to an incorrect commutation factor being applied, the correct pension commencement lump sum should have been £80,000 and the correct scheme pension £12,000. These lower figures represent the member’s true entitlement under the scheme, but the administrator does not want to inconvenience the member too much, and allows the overpayments that have been made so far to stand. They do however adjust the level of pension for the future, reducing it to the member’s correct and true entitlement (see RPSM09108010).

The legitimate part of the lump sum, £80,000, is the true pension commencement lump sum subject to BCE 6. As the matter is covered in the regulations, the remaining part, £318, is tested against the lifetime allowance under BCE 9.

‘Pension commencement’ lump sums finalised after death of the member

[Regulation 19 of the Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171]

Where a BCE arises in the circumstances covered in RPSM09108050 (commencement lump sums paid after death), the amount paid is said to crystallise under BCE9 at the date of death.

Other types of lump sum

With any other type of authorised lump sum (apart from death benefits, see RPSM11104820), the lifetime allowance test is made on the date the member acquires an actual entitlement to the lump sum. For the purposes of the legislation, the member only becomes ‘entitled’ to a lump sum at the point when they first obtain an ‘actual right’ to receive it. This ‘actual right’ has to be distinguished from their ‘prospective right’. An ‘actual right’ is when a member has the right to a lump sum without having to fulfil any further conditions or take any further actions, e.g.

• having to agree to or authorise the payment of a lump sum, or
• having to obtain an employer’s or scheme trustee/scheme administrator’s agreement or co-operation to a lump sum payment.

The lifetime allowance test is carried out using the lifetime allowance at the date of entitlement, which may be different from the date of payment.