PTM054400 - Annual allowance: pension input amounts: pre-6 April 2006 Inland Revenue maximum limits

Pre-6 April 2006 Inland Revenue maximum limits

For the purposes of working out the pension input amount, members’ rights under defined benefits arrangements and cash balance arrangements are calculated using the valuation assumptions. An explanation of what this means in practice is given at PTM053600 and there are some examples in PTM053640.

The benefit rights for members under some registered pension schemes may continue to be determined by reference to elements of the pre-6 April 2006 ‘Inland Revenue maximum limits’. The continued use of such limits will have a bearing on the calculation of the member’s rights under the scheme at the start and end of a pension input period for annual allowance purposes.

An example of where an adjustment might be made to a member’s rights under a pension scheme that continues to use all, or some element of, the pre-6 April 2006 ‘Inland Revenue maximum limits’ is where there is a main target scale of pension, with an overriding limit reflecting the formulae under the pre-6 April 2006 ‘Inland Revenue maximum limits’. Such an overriding limit formula might require the pension equivalent of retained benefits to be taken into account, where ‘retained benefits’ might be benefit rights that the member has in relation to a previous employment. For example, for members joining an employer’s pension scheme after June 1989 the limit might be that:

  • the target pension (including pension equivalent of separate lump sum if relevant) due on retirement from service and pensionable service at the scheme’s normal retirement date is limited to the outcome of a formula along the lines set out in IR 12 ‘Occupational Pension Schemes Practice Notes’
  • which for such a joiner was broadly the greater of (a) and (b)
  • (a) being the lesser of:
    • 1/30th of ‘Final Remuneration’ (IR12 formula reflecting all pay, calculated for such joiners as subject to a limit of the Earnings Cap) for each year of service (up to 20 years) and
    • 2/3rds of Final Remuneration less the pension equivalent at retirement of any retained benefits
  • (b) being 1/60th of Final Remuneration for each year of service.

For annual allowance purposes, the member’s benefit rights for the purpose of establishing the pension input amount are valued on the basis of what would be available to the member if the member retired immediately before the start and at the end of the pension input period (from their status at the time - so, for example, from active status if they are an active member) on the assumption that the member had already reached the age at which, under the scheme’s rules, no reduction applies because of age and with no addition for ill-health.

If a pension scheme has a pre-6 April 2006 ‘Inland Revenue maximum limit’ embedded in its rules, consideration will be needed for pension input amount calculations as to how these would apply under the scheme’s specific rules and wording, had the member reached such an age and become entitled to the benefit rights. In the above example, this could involve identifying a limit based on a fraction, Final Remuneration and/or an assessment of the pension equivalent of retained benefits, for the opening and closing value of the pension input period concerned. In particular a valuation of the retained benefits itself (before converting it to a pension equivalent) could be needed. The exact approach will depend on the nature of the scheme rules.

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Valuation and pension equivalent of retained benefits

The way the retained benefits are to be reflected in assessing uncrystallised pension rights and hence pension input amounts depends fundamentally on the scheme’s rules; what they contain explicitly and how they bring in (if they do) the IR12 ‘Occupational Pension Schemes Practice Notes’ or any other material.

Subject to the way the rules of a pension scheme actually apply, the following would be regarded as a reasonable way to take the pension equivalent of a retained benefit into account for the purpose of calculating pension input amounts. This includes the calculation of pension input amounts for 2008-09 onwards for the purpose of carrying forward unused annual allowance.

Once one assessment has been made of the pension equivalent of total retained benefits for a member for the purpose of pension input amount calculations, there is no need to review or change that assessed amount for that purpose. If no such past assessment for the purpose of pension input amount calculations has been made, then a current assessment can be made and used not only for future such pension input amount calculations but also for past pension input calculations for the purpose of carrying forward unused annual allowance.

The following examples show how the application of pre-6 April 2006 ‘Inland Revenue maximum limits’ might have a bearing on the pension input amount for a particular example of a scheme’s operation of the pre-6 April 2006 ‘Inland Revenue maximum limits’ - each scheme will need to consider its own rules.

Example 1 - ‘post-1989 Inland Revenue limits’ apply without any retained benefits

The scheme has the same age for normal retirement age for pre-6 April 2006 ‘Inland Revenue limits’ (IR limits) purposes, and for pension age for the purposes of the valuation assumptions.

The pension scheme rules promise a pension on retiring from service and pensionable service at the scheme’s normal pension age of:

  • a target main formula, that for annual allowance purposes is read as 2/3 x pensionable salary (note that this could have arisen because the scheme rules promise a pension on retiring from service at NRD of 2/3rds; on early leaving the formula is N/NS x 2/3 as deferred pension (before revaluation), and on early retirement from service this leaver pension is granted, reduced for early payment - see PTM053310 on Non-uniform accrual scales and the examples in PTM053640)
  • but subject to an IR limits formula which for the member concerned is 1/30th of Final Remuneration (calculated subject to a limit of the Earnings Cap) for each year of service (up to 20 years) but subject to the benefits from the employer’s scheme together with the pension equivalent of any retained benefits not exceeding 2/3rds of Final Remuneration - or if overall higher, 1/60th of Final Remuneration for each year of service.

Member is in year 19 of company and pensionable service immediately before start of the pension input period ending in 2012-2013 and has a pensionable salary of £115,000 and Final Remuneration for IR limits purposes allowing for other remuneration of £120,000 (noting that the cap on Final Remuneration for IR limits at that time is £123,000 so did not bite).

Salary at the end of the pension input period is something above £130,000 but pensionable salary and Final Remuneration are set to £125,000 (cap on Final Remuneration is £125,000).

CPI increase for 12 months to September 2011 is 5.2%.

If the rules did not have an IR limit the pension input amount would be £42,896 as follows:

  • opening value - [2/3 x £115,000 = £76,667] x 16 x 1.052 = £1,290,459
  • closing value - [2/3 x £125,000 = £83,333] x 16 = £1,333,328
  • pension input amount = £42,869 (£1,333,328 - £1,290,459).

However, the application of the IR limits means the pension input amount is £54,096:

  • opening value - [19/30 x £120,000 = £76,000] x 16 x 1.052 = £1,279,232
  • closing value - [20/30 x £125,000 = £83,333] x 16 = £1,333,328
  • pension input amount = £54,096 (£1,333,328 - £1,279,232).

Example 2 - ‘post-1989 Inland Revenue limits’ apply with retained benefits in an other money purchase arrangement

Same data as example 1 except that the member has a retained benefit in the form of an other money purchase arrangement.

The rules of this particular scheme are such that, in this particular case, the scheme administrator identifies that there is no need for obtaining updated fund values or changing the calculated pension equivalent of the fund value. The last valuation that the scheme holds for the retained benefit is a fund value of £100,000 and a pension equivalent of £9,000 per annum.

If the rules did not have an IR limit the pension input amount would be £42,896 as follows:

  • opening value - [2/3 x £115,000 = £76,667] x 16 x 1.052 = £1,290,459
  • closing value - [2/3 x £125,000 = £83,333] x 16 = £1,333,328
  • pension input amount = £42,869 (£1,333,328 - £1,290,459).

However, the application of the IR limits means the pension input amount is nil.

Pension right to be measured for the opening value is:

  • the lesser of 2/3 x pensionable salary
  • and the IR limit of:
    • lesser of 2/3 x Final Remuneration less retained benefits
    • and 19/30 x Final Remuneration
  • which is the lesser of 2/3 x £115,000 = £76,667
  • and the IR limit of:
    • lesser of ([2/3 x £120,000 = £80,000] - [£100,000 x 0.09 = £9,000]) = £71,000
    • and 19/30 x £120,000 = £76,000.

So overall the pension right to be measured is £71,000.

The pension right to be measured for the closing value is:

  • the lesser of 2/3 x pensionable salary
  • and the IR limit of:
    • lesser of 2/3 x Final Remuneration (capped) less retained benefits
    • and 20/30 x Final Remuneration (capped)
  • which is the lesser of 2/3 x £125,000 = £83,333
  • and the IR limit of:
    • ([2/3 x £125,000 = £83,333] - [£100,000 x 0.09 = £9,000]) = £74,333.

So overall the pension right to be measured is £74,333.

Opening value - £71,000 x 16 x 1.052 = £1,195,072.

Closing value - £74,333 x 16 = £1,189,328.

Pension input amount is £0 (a zeroing of the outcome of -£5,744 = £1,189,328 - £1,195,072).

In this case the last valuation of the retained benefit held on file by the scheme has been used for calculating both the opening and closing values. If the nature of the scheme rules was that the assessment of retained benefits must use a current valuation at the time of the opening value and closing value, the pension input amount could vary depending on difference in valuation at the two dates. For example, the pension input amount could increase if the retained benefit had a greater value at the time of the opening value compared to the value of the retained benefit at the time of the closing value.

The scheme administrator will need to decide what information it needs and request this from the member. If the scheme administrator cannot obtain information on retained benefits, it may not have sufficient information to provide the member with pension input amount information. Where the scheme administrator would normally have expected not to require this information from the member until the time that benefits were taken, the administrator may need to explain the need to have this information at an earlier date to help the member to understand why they need to provide the information to the administrator.