RPSM09104150 - Technical Pages: Member benefits: Lump sums: Pension commencement lump sum: Overview: Lump sum from a pension under a different arrangement in the same scheme

If the lump sum was paid on or after 6 April 2011 you should first read RPSM09104195 

A pension commencement lump sum may be connected to an arising pension entitlement under a different arrangement under the same registered pension scheme

Normally, a lump sum may only be treated for tax purposes as a pension commencement lump sum if the member has actually become entitled to a relevant pension benefit under the registered pension scheme making the lump sum payment. The maximum amount payable will be capped by reference to the value of that arising pension entitlement. RPSM09104130 and RPSM11102050 explain what a relevant pension is and what is meant by an actual rather than a prospective entitlement to a benefit. Following changes made by FA 2005, the pension entitlement giving rise to the pension commencement lump sum payment does not have to arise under the same arrangement paying the lump sum. The pension commencement lump sum can be linked to an arising pension entitlement under one or more different arrangements the member holds in the same registered pension scheme, as well as any entitlement arising under the arrangement making the lump sum payment.

This flexibility means that the maximum pension commencement lump sum payable may be calculated on a scheme-wide basis, based on all that member’s entitlements arising under that scheme. And that the member can be given the choice of drawing their lump sum entitlement from one source under a scheme, rather than potentially drawing two or more smaller lump sum payments from different types of arrangements held under the scheme.

For example, many registered pension schemes providing a defined benefit entitlement to its members do not extend this to additional voluntary contributions (AVCs) paid by the member. These AVCs will be held under a money purchase arrangement(s) whilst the main scheme benefits are held separately under a defined benefit arrangement(s). Instead of drawing two separate lump sum payments from each arrangement, based on the pension entitlement from each arrangement, the scheme can give the member the option of drawing more (or all) of their total lump sum entitlement under the scheme from the money purchase arrangement(s) holding their AVC benefits. This means that the member can use any funds generated from their AVC fund, that would otherwise be used to purchase a small lifetime annuity, to provide all their lump sum benefit. The extra main scheme benefits retained in the defined benefits arrangement are used to generate a higher scheme pension.

This flexibility can also be used where benefits are provided under a scheme entirely on a money purchase basis. For example, the member may hold two policies under the scheme in different arrangements, each one with a different insurance company, and wish to use the contract with the worst annuity rate to provide their lump sum benefit.

Where a pension commencement lump sum is paid that has been generated, either in full or in part, by cross-reference to a pension entitlement under a different arrangement under the same scheme, any lump sum entitlement arising under that other arrangement must take into account that other payment.

RPSM09104310 and RPSM09104270 give more information with an example on RPSM09104280.