RPSM11104410 - Technical Pages: Lifetime allowance: Valuing benefits on BCEs: Augmenting a scheme pension - BCE 3: Example of the permitted margin for pre 6 April 2006 pensions

Example of the calculation of the permitted margin where entitlement to the scheme pension arose before 6 April 2006

Marilyn became entitled to a pension from an occupational pension scheme on 1 April 2004 starting (after commutation for a tax-free lump sum) at £10,000 per annum. Marilyn’s maximum pension under HMRC rules (after allowance for commutation) was £20,000 per annum.

On 5 April 2006 Marilyn is entitled under the scheme rules to a rate of increase of 6% per annum. This is subject to HMRC maximum benefit limits.

The scheme becomes a registered pension scheme on 6 April 2006, with the ongoing pension becoming a scheme pension.

In March 2007 Marilyn’s pension is being increased. For the purpose of this example, it is assumed that the increase will exceed the threshold annual rate (see RPSM11104341 for more details).

The maximum permitted margin Marilyn’s pension can be raised to is the higher of two measures:

• (the usual default permitted margin approach) The margin reached if her starting entitlement of £10,000 per annum on 1 April 2004 had been increased by the higher of 5% per annum compound or by RPI to March 2007, or
• The margin reached if the £10,000 pension had been increased from 1 April 2004 by 6% per annum compound up until March 2007. This is subject to HMRC maximum benefit limits not being exceeded.

With both measures the revaluation is over the period from April 2004 to March 2007 (36 months, counting the first and last month as a complete month).

Under the first measure the permitted margin comes out as calculation A (which is higher than the RPI measure through calculation B). If the £10,000 starting entitlement is increased by 5% per annum compound over the 36 month period Marilyn’s pension would be increased to £11,576 per annum. £11,576 per annum is therefore the permitted margin Marilyn’s pension could be increased by to under the first measure.

Under the second measure the permitted margin is calculated by the same process as through calculation A above, but by reference to an annual percentage increase of 6%, as specified in the scheme rules on 5 April 2006 (P%). If the £10,000 starting entitlement is increased by 6% per annum compound over the 36 month period Marilyn’s pension would be increased to £11,910 per annum. The figure of £11,910 is then compared with the HMRC maximum pension that applied in respect of Marilyn on 1 April 2004 (£20,000), increased by the maximum allowable under pre 6 April 2006 HMRC rules. The revised maximum pension figure is £21,854 per annum (£20,000 increased by 3% per annum compound for the 36 month period - assuming 3% per annum compound gives a greater increase than the increase in RPI would for the same period). Therefore the amount of £11,910 per annum is the permitted margin Marilyn’s pension could be increased to under the second measure.

If Marilyn’s scheme pension is increased beyond £11,910 in March 2007 the excess (XP) crystallises for lifetime allowance purposes through BCE 3.

Suppose instead that in Marilyn’s scheme rules as at 5th April 2006, there was power (for the Trustees at their discretion or on instruction from the company or under the general benefit augmentation power) to grant additional increases to pensions in payment so long as the resulting pension did not exceed the old HMRC maximum benefit limit. This would mean that the permitted margin is £21,854 pa and any level of pension granted up to this level would not cause any XP and there would be no BCE3. (It is noted that the administrator may, in this situation, in practice identify a simple “no-less-than figure” for the HMRC limit, that demonstrates that there is no BCE3 without going to the detail of actually calculating the absolute HMRC limit.)

If Marilyn’s pension later becomes increased in May, 2008, the way that the RPI increase is measured can change. For increases on or after 6 April 2008, instead of RPI being measured by reference to the period from the month of the start of the pension to the month of the increase, the scheme administrator can use a different period. The scheme administrator can take any month in the last 12 months ending with the month of the current increase, the reference month (see RPSM11104395), so for example March 2008, so long as the period begins from the same number of months before the month of the start of the pension (the base month) as the reference month is to the month of the current increase. So in this instance, February 2004. So the RPI would be measured from February 2004 to March 2008.