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Pensions Tax Manual

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Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: primary protection and lump sum protection

Glossary PTM000001
   

Lump sum protection available for individuals with primary protection
How protection of lump sums with primary protection works
Lump sum rights that exceed £375,000 and primary protection: notification and certificate
Protection of lump sums exceeding £375,000 with primary protection: all benefits are taken from a scheme as a stand-alone lump sum
Annual allowance consequences where all benefits are taken on or after 6 April 2015 from a money purchase arrangement as a stand-alone lump sum
Protection of lump sums with primary protection: taking benefits at different times - some lump sum benefits are not tax-free
Scheme chargeable payments: unauthorised lump sum payments

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Lump sum protection available for individuals with primary protection {#IDAVVHBC}

Paragraph 28 Schedule 36 Finance Act 2004

The guidance on this page applies where the total value of an individual’s crystallised and uncrystallised lump sum rights on 5 April 2006 was more than £375,000.

If an individual with total lump sum rights of £375,000 or less had on 5 April 2006 in any one pension scheme uncrystallised lump sum rights of more than 25% of the value of their total uncrystallised rights in that scheme - see PTM063130.

If an individual with total lump sum rights of £375,000 or less did not on 5 April 2006 have uncrystallised lump sum rights of more than 25% of the value of their total uncrystallised rights in that scheme, there is no lump sum protection. The normal payment rules for pension commencement lump sums will apply - see PTM063200.

In an exceptional case, if you should need to consult fuller guidance on valuing lump sum rights in this context, please see page RPSM03105000 in the Registered Pension Schemes Manual, on  The National Archives{.ext.no-outline} website (external users please see http://webarchive.nationalarchives.gov.uk/20140504142140/http://www.hmrc.gov.uk/manuals/rpsmmanual/RPSM03105000.htm{.ext}). 

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How protection of lump sums with primary protection works

Paragraph 28 Schedule 36 Finance Act 2004

Individuals are able to take a pension commencement lump sum (see PTM063200) when they take some or all of their pension benefits.

Pension commencement lump sums are not, apart from the lifetime allowance charge, subject to income tax. The maximum pension commencement lump sum is 25% of the standard lifetime allowance at the time the lump sum is paid unless an individual has protected lump sum rights.

Primary protection requires uncrystallised lump sum rights at 5 April 2006 to be valued, and uses that figure to modify the individual’s authorised pension commencement lump sum. Effectively this means that the starting point for an individual’s protection is the value of the rights on 5 April 2006 rather than the pension commencement lump sum normally permitted under paragraph 1 Schedule 29 Finance Act 2004. The value of those rights is then re-valued at the date the lump sum is paid. Up to 5 April 2011, the lump sum rights valued on 5 April 2006 were increased in the same way as the standard lifetime allowance. From 6 April 2012, until such time as the standard lifetime allowance at the time the lump sum is taken is more than £1.8 million, the amount by which the pre-6 April 2006 lump sum rights are increased will always be 20% of the value of the lump sum rights on 5 April 2006.

To be paid a pension commencement lump sum, an individual must have available lifetime allowance.

The available lifetime allowance does not have to cover the whole of the amount paid as a lump sum payment. With primary protection it is possible to be paid a pension commencement lump sum, part of which is liable to the lifetime allowance charge.

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Lump sum rights that exceed £375,000 and primary protection: notification and certificate

Regulations 3 and 10 The Registered Pension Schemes (Enhanced Lifetime Allowance) Regulations 2006 - SI 2006/131

Individuals who notified HMRC that they intended to rely on primary protection for their pension rights could protect from the lifetime allowance charge total lump sum rights valued at 5 April 2006 at more than £375,000.

This was done by individuals giving details of their lump sum rights when they notified HMRC of their pension rights for primary protection. Where this was done, HMRC issued a certificate to the individual confirming primary protection with the additional lifetime allowance being shown as a factor of the £1.5 million standard lifetime allowance applying in tax year 2006-07. This certificate also shows the amount of the protected lump sum expressed as a monetary amount.

Where this form of lump sum protection applies, it takes precedence over scheme-specific lump sum protection (see PTM063130).

Example of lump sum protection: taking all benefits at same time with the whole lump sum payable as a pension commencement lump sum

Dilip had lump sum rights on 5 April 2006 of £1 million and has primary protection on total benefit rights of £5 million. His lifetime allowance enhancement factor is 2.34.

Dilip takes all of his benefits in June 2015 when the standard lifetime allowance is £1.25 million. His total benefit rights, which are held in a money purchase arrangement, are valued at £6.8 million. The amount of Dilip’s protected pension rights are now £6.012 million (£1.8 million + £1.8 million x 2.34 = £6.012 million) and his lump sum rights are now £1.2 million (£1 million x 1.8/1.5).

Dilip decides to take a pension commencement lump sum of £1.2 million, which is equal to the maximum allowed, and designates the remaining £5.6 million into a flexi-access drawdown fund to provide drawdown pension. As the value of benefits paid (£6.8 million) is more than the value of his primary protection (£6.012 million), there is a lifetime allowance charge on the excess (£788,000). As the pension commencement lump sum crystallises first for lifetime allowance purposes it is the amount designated to drawdown which exceeds the available lifetime allowance. The rate of the lifetime allowance charge is 25%, so the tax due is £197,000. The scheme administrator deducts this amount from the £5.6 million leaving £5.403 million available to provide flexi-access drawdown.

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Protection of lump sums exceeding £375,000 with primary protection: all benefits are taken from a scheme as a stand-alone lump sum

Articles 25 to 25D The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

A pension commencement lump sum cannot be paid where all the benefits are being paid in lump sum form because a pension commencement lump sum must be paid in connection with an arising entitlement to a pension.

However, where certain conditions are met it is possible for all of a member’s uncrystallised rights in a registered pension scheme to be paid as a lump sum. This is known as a stand-alone lump sum.

Under the protection rules for lump sum rights exceeding £375,000 with primary protection, a monetary amount of lump sum is protected across all schemes the individual is a member of. Individuals can then choose, subject to scheme rules, the amount of lump sum they take from each scheme. So an individual may take all the benefits from a particular scheme as a stand-alone lump sum, if the rules of the scheme allow this. This can happen where:

  • the member has reached the normal minimum pension age (or any earlier protected pension age they may have under the scheme - see PTM062210) or is taking benefits earlier due to ill-health - see PTM062100, and
  • all the member’s uncrystallised rights under the scheme come into payment as a single benefit crystallisation event (BCE).

Like a pension commencement lump sum, a payment of a stand-alone lump sum is a BCE 6. This means that the stand-alone lump sum is subject to the lifetime allowance charge if the individual does not have enough available lifetime allowance to cover the payment - see PTM081000. Apart from this, a stand-alone lump sum can be paid tax-free, as with a pension commencement lump sum - see PTM063200.

Amount of lump sum

The amount of the stand-alone lump sum is limited by the formula

VULSR - APCLS

Where

VULSR = value of the member’s uncrystallised lump sum rights as at 5 April 2006

(for guidance on valuing rights at 5 April 2006, please see the National Archives on http://webarchive.nationalarchives.gov.uk/20140504142140/http://www.hmrc.gov.uk/manuals/rpsmmanual/RPSM03105030.htm)For lump sums paid on or after 6 April 2012, that value is increased by 20%, until such time as the prevailing standard lifetime allowance at the time the lump sum is taken is more than £1.8 million.

APCLS = value of any pension commencement lump sum and/or stand-alone lump sum that has previously been paid to the member (increased in line with the increase of the standard lifetime allowance). From 6 April 2012, the lump sum paid previously is increased by multiplying the amount of that lump sum by £1.8 million (or the standard lifetime allowance at the time the further lump sum is paid if this is greater), then dividing by the standard lifetime allowance at the time of payment. For example, if the further lump sum was paid in tax year 2012-13 when the standard lifetime allowance was £1.5 million, and the previous lump sum (£300,000) was paid in tax year 2007-08 when the standard lifetime allowance was £1.6 million, the previous lump sum is increased as follows - £300,000 x £1.8 million/£1.6 million giving an increased amount of £337,500.

When a pension commencement lump sum is taken after a stand-alone lump sum has been taken the maximum allowable lump sum is adjusted to take account of the stand-alone lump sum that has previously been paid.

Example of payment of a stand-alone lump sum to a member with primary protection and lump sum rights of more than £375,000

Peter made a valid notification of primary protection to HMRC. The amount of his protected lump sum rights is £600,000. In May 2007 Peter decided to take benefits from a scheme with funds of £400,000.

At that time the standard lifetime allowance was £1.6 million so Peter’s protected lump sum rights had a value of £640,000 (£600,000 x £1.6 million/£1.5 million).

Peter was aged 60 and the amount in the scheme was less than the amount of his protected lump sum rights. So Peter was able to take the whole amount as a stand-alone lump sum. Peter took £400,000 as a stand-alone lump sum, which was paid tax free as he had not used up his available lifetime allowance.

Just over 5 years later when the standard lifetime allowance was is £1.5 million Peter decided to crystallise further benefits from a couple of his schemes. Scheme 1 had a value of £250,000 and scheme 2 had a value of £2 million.

The value of Peter’s available protected lump sum rights was £270,000.

(£600,000 x £1.8/1.5 million) - (£400,000 x £1.8/1.6 million) = £270,000.

Peter crystallises the whole £250,000 from scheme 1 as a stand-alone lump sum. From scheme 2 he takes a pension commencement lump sum of £20,000 (being the remainder of his protected lump sum rights). The remaining £1.98 million is used to provide a pension.

Example of lump sums with primary protection when benefits taken at different times: example of a stand-alone and then a pension commencement lump sum payment

Sally had protected lump sum rights of £1 million on 5 April 2006 and had primary protection on pension rights of £5 million. She held her rights in two arrangements. Her lump sum rights are payable by commuting pension rights.

She took benefits on 23 April 2009, her 55th birthday, from the smaller of the two arrangements. The standard lifetime allowance in 2009/10 was £1.65 million. The amounts of her protected pension and lump sum had increased in line with the increase in the standard lifetime allowance to £5.5 million and £1.1 million (each amount being multiplied by £1.65 million/£1.5 million).

As the smaller arrangement, a money purchase arrangement, was valued at £600,000 she chose to take all her benefit as a stand-alone lump sum.

Sally takes benefits from her second arrangement in 2015-16 when the standard lifetime allowance is £1.25 million. The amounts of her protected pension and lump sum have increased to £6 million and £1.2 million.

Sally had taken benefits previously so the amounts of benefits currently protected must be reduced by the value of the earlier benefits. The value of the earlier benefits must be increased in line with the increase in the standard lifetime allowance from its value when the benefits were taken to its current value. In this example, the standard lifetime allowance has reduced from £1.65 million to £1.25 million. However, the reduction has no impact because the figure of £1.8 million will replace the actual standard lifetime allowance.

The value of the £600,000 stand-alone lump sum taken in 2009 is therefore £654,545 (£600,000 x 1.8/1.65).

Sally’s available protected pension and lump sum are therefore £5,345,455 (£6 million - £654,545) and £545,455 (£1.2 million - £654,545) respectively.

Her second arrangement is a money purchase arrangement worth £8.3 million. She takes a pension commencement lump sum of £545,455 and uses the remainder of her protected pension rights, £4.8 million, to buy a lifetime annuity.

The remaining £2,954,545 in the arrangement (£8.3 million less protected pension rights of £5,345,455) is liable to the lifetime allowance charge. From this, she takes a lifetime allowance excess lump sum of £1,329,545 after deduction of the 55% lifetime allowance tax charge (£1,625,000).

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Annual allowance consequences where all benefits are taken on or after 6 April 2015 from a money purchase arrangement as a stand-alone lump sum

Paragraph 25C (4) Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

Where a member with primary protection and protected lump sum rights is paid a stand-alone lump sum on or after 6 April 2015 under a money purchase arrangement then, for the purposes of the money purchase annual allowance rules (see PTM056510), section 227G Finance Act 2004 is to be read as if there were a subsection stating that the member first flexibly-accessed pension rights immediately before the stand-alone lump sum was paid. However, this modification to section 227G does not apply where, on or after 6 April 2015, the member had already taken a stand-alone lump sum from a money purchase arrangement or the member has already been treated as first flexibly-accessing pension rights under one of the other subsections of section 227G.

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Protection of lump sums with primary protection: taking benefits at different times - some lump sum benefits are not tax-free

Jane has primary protection for her pension rights, and her lump sum rights on 5 April 2006 exceeded £375,000. She has already taken some benefits after 5 April 2006 under primary protection.

Her remaining rights are in a money purchase arrangement, which are valued at £1 million. Her remaining protected pension rights are valued at £600,000, which means her available personal lifetime allowance is £600,000. The amount of protected lump sum is £700,000 - her protected lump sum rights are greater than her available personal lifetime allowance.

Jane has been unable to take all of her protected lump sum amount tax-free because the maximum amount of pension commencement lump sum exceeds the amount of her available lifetime allowance.

Jane takes a lump sum of £700,000, using up all of her available lifetime allowance (£600,000). £600,000 of the lump sum can be paid as a tax-free pension commencement lump sum. But the amount of the lump sum (£100,000) in excess of Jane’s available lifetime allowance cannot be paid as a pension commencement lump sum. As she has no lifetime allowance available, the excess can be paid as a lifetime allowance excess lump sum and taxed accordingly (see PTM084000). The £300,000 balance (£1 million - £700,000) is to be used to purchase a lifetime annuity. As Jane has no lifetime allowance available, she will be liable to the 25% lifetime allowance charge on the balance leaving £225,000 available to purchase an annuity.

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Scheme chargeable payments: unauthorised lump sum payments

Paragraph 30 Schedule 36 Finance Act 2004

Paragraph 30 Schedule 36 Finance Act 2004 exempts scheme administrators in specified circumstances from a tax charge that would otherwise apply under section 239 Finance Act 2004.

Section 239 Finance Act 2004 levies a tax charge called the scheme sanction charge where the scheme makes an unauthorised payment. Under paragraph 30 of Schedule 36 Finance Act 2004, this tax charge will not arise where:

  • an unauthorised lump sum payment is made
  • the recipient makes or has already made a valid claim for primary protection and/or enhanced protection and their lump sum rights exceeded £375,000 in value on 5 April 2006, and
  • the lump sum paid to the recipient would have been an authorised payment (a pension commencement lump sum) had the operation of paragraphs 2 and 3 Schedule 29 not been modified to reduce the permitted maximum or applicable amount because the recipient had protected lump sum rights.

The effect of paragraph 30 is that a scheme administrator is not liable to a tax charge when paying a lump sum not exceeding 25% of the value of the benefits coming into payment to a recipient who has not used up all of their standard lifetime allowance. The excess amount is however still an unauthorised member payment so the member will still be liable to the unauthorised payments charge.