RPSM09104286 - Technical Pages: Member benefits: Lump sums: Pension commencement lump sum: Maximum amount: General: Example of lump sum paid from a money purchase arrangement that spawns a new defined benefit arrangement for the provision of scheme pension

Example of a pension commencement lump sum based on a pension entitlement arising under another arrangement in the same registered pension scheme that triggers an anti avoidance rule

This twin-example highlights an action that might lead to a payment that is caught by an anti-avoidance rule.

Sue has uncrystallised rights under a single money purchase arrangement in a registered pension scheme. The fund is worth £150,000.

Sue rejects the offer of a lifetime annuity and opts instead to have three quarters of the fund (£112,500) used to provide her with an insurance-backed scheme pension of £11,250 p.a.

The remaining quarter is used to provide her with a pension commencement lump sum of £37,500. This does not exceed the limit on the applicable amount outlined at RPSM09104405, namely one third of the scheme pension purchase price. Also Sue has not crystallised benefits up to the standard lifetime allowance so the available portion of the member’s lump sum allowance does not restrict the applicable amount of £37,500. The lump sum can be paid to her tax-free.

Suppose now that Sue has a twin sister Gill. Gill has an identical pensions saving background, right down to being in the same scheme as Sue and having saved the same amount (£150,000) in a money purchase arrangement there. But there is a difference in how Gill’s benefits are paid out.

Gill wants to take a lump sum of £60,000, so the other £90,000 is separated out to create a defined benefit arrangement. This newly created arrangement is used to provide a scheme pension of £9,000 p.a.

On the face of it, a lump sum of £60,000 could be justified by the pension from a defined benefit arrangement. The usual formula for use with defined benefit scheme pensions is that outlined at RPSM09104400, as follows:

But this can be the wrong formula to use here, as we shall see.

The above calculation would be OK, were it not for the fact that scheme pensions that somehow originate from a money purchase background, may still be subject to the formula that applies for pensions arising under money purchase arrangements after all. That other formula is ‘scheme pension purchase price’ / 3, which in this case = £90,000 / 3 = £30,000. This is in effect the same formula as that described at RPSM09104405.

The criteria for whether the money purchase formula is applied here, is outlined in RPSM09104406 and RPSM09104407. In short it applies whenever the purpose for adopting different payment methods like Gill’s, or other actions like hers, is mainly to boost the lump sum above the otherwise normal tax-free amounts. In other words, the money purchase formula is applied in cases of deliberate avoidance.

For the sake of this example, let’s say that avoidance is clearly why Gill opted for this payment method. Gill thought she could have more lump sum if she channelled funds through a defined benefit arrangement, so that is why she chose this method.

In such a case the “extra” £30,000 (calculated as £60,000 - £30,000) is unauthorised. This is so even though Gill only stood to gain £22,500 more than her sister Sue, had the anti-avoidance rule not existed. This is because the anti-avoidance rule does not compare actual provision with what might have been done, rather it applies tests on the basis of what is actually done.

Comment:

It may be helpful to compare the above example of Gill’s benefits with the preceding example at RPSM09104284. The anti-avoidance provisions outlined in Gill’s case were not triggered in the RPSM09104284 example, because there was no ‘relevant surrender’ there, nor was there any ‘relevant transfer’ there. The rights under the defined benefit arrangement in RPSM09104284 had not originated under a money purchase arrangement at all.