RPSM11101190 - Technical Pages: Lifetime allowance: Level of lifetime allowance: Reduction where a member has a protected pension age

Reduction in lifetime allowance if a member has a protected pension age

In certain circumstances, a member may have a right to a protected pension age if they had a right on 5 April 2006 under their scheme rules to draw benefits before the normal minimum pension age (see RPSM03106000). Where a member has a protected pension age of less than 50 under a registered pension scheme there is a knock-on effect for lifetime allowance purposes where they exercise that right.

Where the member draws benefits before 50, their level of lifetime allowance must be reduced by what is called the relevant percentage. This is because the crystallised value for lifetime allowance purposes of any benefits drawn will not adequately reflect the true capital value of that benefit, as it has been drawn so early in the individual’s lifetime.

For example, the crystallised value of a £20,000 per annum scheme pension for lifetime allowance purposes is £400,000, whether it is paid to a member at age 40 or age 60. However, the cost of securing a pension starting at age 40 is far greater than the cost of securing the same pension payable from age 60 (as the pension payable from age 40 will be potentially payable for much longer). So the true capital value of that pension is far greater.

The level of the individual’s lifetime allowance is therefore reduced to reflect this early payment. This means that the percentage of the lifetime allowance that the crystallisation of the scheme pension uses up will be correspondingly increased.

If for example the individual’s lifetime allowance would normally be £1.5 million at this point, and the relevant percentage is 25%, the individual’s lifetime allowance will be reduced to £1,125,000. Using the example above, the £400,000 crystallising in relation to the scheme pension coming into payment at 40 therefore use up 35.56% of the individual’s lifetime allowance, rather than only 26.66% if compared to the normal lifetime allowance entitlement.

How the relevant percentage is calculated is explained in detail in RPSM03106080. The earlier the benefits are paid before the normal minimum pension age the higher the relevant percentage will be. So the earlier the benefits are drawn the more lifetime allowance will be used up.

The same principle applies if the member is entitled to an enhanced lifetime allowance. The reduction is simply applied to the enhanced level of lifetime allowance, rather than the standard lifetime allowance. An individual’s lifetime allowance will be calculated in exactly the same way as described in RPSM11101090 (that is, by reference to the standard lifetime allowance and any lifetime allowance enhancement factors). The scheme administrator will then reduce the resulting lifetime allowance figure by the appropriate relevant percentage.

A reduction by the relevant percentage is only applied where a BCE occurs in relation to the arrangements in the registered pension scheme where that right is held, and only where those benefits are actually drawn before the normal minimum pension age.

This reduction does not apply where an individual retains the right to draw benefits before age 55 because of existing rights held on 5 April 2006, but where that protected pension age is 50 or higher.