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HMRC internal manual

Pensions Tax Manual

Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: scheme-specific lump sum protection - valuation

Glossary PTM000001
   

 

Scheme-specific lump sum protection
Valuation of lump sum rights to be protected: general
Valuing pension and lump sum rights where the lump sum rights exceeding 25% are in a single arrangement
Valuing pension and lump sum rights where the lump sum rights exceeding 25% were in more than one arrangement or pension scheme and were within HMRC limits
Valuing pension rights and lump sum rights where the lump sum rights exceeding 25% were in more than one arrangement or pension scheme and the value of either type of rights exceeded HMRC limits

 

 

Scheme-specific lump sum protection

 

See PTM063130 for a full overview of scheme-specific lump sum protection.

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Valuation of lump sum rights to be protected: general

Paragraph 32 Schedule 36 Finance Act 2004

Only lump sums that could have been paid under the tax regime in existence before 5 April 2006 can be protected. This means an individual’s protected lump sum rights (referred to as VULSR in the legislation) must be within the HMRC limits for tax-free lump sums that applied at 5 April 2006. Valuing an individual’s lump sum rights on 5 April 2006 is therefore a three step process.

Step 1

Identify the individual’s lump sum entitlement under the scheme. The scheme rules will set out what this is.

Step 2

Identify the individual’s maximum allowable lump sum under HMRC limits for each pensionable employment.

Step 3

Where the lump sum entitlement for a pensionable employment under step 1 is more than the HMRC allowable lump sum for that pensionable employment under step 2 the lump sum entitlement under step 1 must be cut back.

A similar three step process applies to the valuation of pension rights (referred to as VUR in the legislation) on 5 April 2006.

In an exceptional case, if you should need to consult fuller guidance on valuing lump sum rights in this context, please see pages RPSM03105529 to RPSM03105570 in the Registered Pension Schemes Manual, on The National Archives website.

Under the pre-6 April 2006 tax rules, protected rights and additional voluntary contributions that were started after 7 April 1987 could not be commuted into a lump sum. So they cannot be included in the scheme lump sum entitlement under step 1 above. Similarly, many scheme rules allowed for the payment of a lump sum of an amount up to HMRC limits. Where there were insufficient funds in the scheme to provide this maximum amount, the scheme entitlement under step 1 is instead the lower amount of the available funds.

Example

On 5 April 2006, Susan was a member of a pension scheme providing benefits on a money purchase basis. The scheme rules allowed for the payment of a lump sum up to HMRC limits. Under HMRC limits, Susan’s maximum lump sum was £50,000. However the value of Susan’s rights under the scheme on 5 April 2006 was £45,000. Of that amount £5,000 related to AVCs that she started to pay in 1997. Another £10,000 of the funds represented protected rights.

So on 5 April 2006, the amount that was available to provide a lump sum was only £30,000. This is the amount of Susan’s lump sum entitlement under the scheme that should be shown at step 1.

Find more information under the headings below, with examples, of the valuation of VULSR and VUR in specific circumstances.

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Valuing pension and lump sum rights where the lump sum rights exceeding 25% are in a single arrangement

Where the individual has a single arrangement under a sole pension scheme in respect of the employment, the value of their uncrystallised lump sum rights on 5 April 2006 (VULSR) and the value of their total uncrystallised pension rights on 5 April 2006 (VUR) under the scheme are as follows.

VULSR

Paragraphs 32(1) and 25(5) Schedule 36 Paragraphs 32(2, 5 and 7) and 26 Schedule 36 Finance Act 2004

VULSR is the lower of the value of the lump sum rights determined under paragraphs 25(5) and 26 Schedule 36 Finance Act 2004.

The value under paragraph 25(5) is the value of the entitlement to uncrystallised lump sum rights under the arrangement on 5 April 2006 - see the archived guidance in the Registered Pension Schemes Manual at RPSM03105070 on The National Archives website.

The value under paragraph 26 is the HMRC maximum permitted lump sum - see PTM063110 and PTM063120. So the value under paragraph 26 only applies where the value of the lump sum rights under the arrangement was more than the maximum permitted lump sum under HMRC limits on 5 April 2006.

VUR

Paragraphs 8(5), 9(3), 33(1) and 33(2, 5 and 7) Schedule 36 Finance Act 2004

VUR is the lower of the value calculated under paragraphs 8(5) and 9(3) Schedule 36 Finance Act 2004.

The value under paragraph 8(5) is the entitlement to uncrystallised pension rights under the arrangement on 5 April 2006.  The valuation method depends on the type of the arrangement.  Please see the archived guidance at RPSM03101050 to RPSM03101100 in the Registered Pension Schemes Manual, on The National Archives website.

The value under paragraph 9(3) is the HMRC maximum permitted pension. PTM062000 onwards explain how this value is obtained.

The value under paragraph 9(3) only applies where the entitlement to pension rights under the arrangement is more than the maximum permitted pension under HMRC limits.

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Valuing pension and lump sum rights where the lump sum rights exceeding 25% were in more than one arrangement or pension scheme and were within HMRC limits

Where the individual had more than one arrangement under a sole pension scheme, or more than one pension scheme in respect of the employment, and neither the value of the lump sum rights nor the value of the pension rights exceeded the value of the HMRC limit for the employment on 5 April 2006, VULSR and VUR are as follows.

VULSR

Paragraphs 32(1 to 2) and 25(5) Schedule 36 Finance Act 2004

VULSR is the value of the lump sum rights determined under paragraph 25(5) Schedule 36 Finance Act 2004 for the arrangement(s) under each scheme - the details below explain what this value is.

VUR

Paragraphs 33(1 to 2) and 8(5) Schedule 36 Finance Act 2004

VUR is the value of the pension rights determined under paragraph 8 Schedule 36 Finance Act 2004 for the arrangement(s) under each scheme. The further information and examples below explain what this value is depending on the types of arrangement involved.

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Valuing pension rights and lump sum rights where the lump sum rights exceeding 25% were in more than one arrangement or pension scheme and the value of either type of rights exceeded HMRC limits

Where the individual had more than one arrangement under a sole pension scheme or more than one pension scheme in respect of the employment, and either the value of the lump sum rights or the value of the pension rights exceeded the value of the HMRC limits for the employment on 5 April 2006, VULSR and VUR are as follows.

VULSR

Paragraphs and 25(5), 26, 32(1) and 32(2, 4, 6, 8 and 9) Schedule 36 Finance Act 2004

VULSR is the total value of the uncrystallised lump sum rights determined under paragraph 25(5) Schedule 36 Finance Act 2004 for each arrangement under the scheme after any appropriate adjustment to the value of the lump sum rights under each arrangement. The adjustment is a deduction from the value of the lump sum rights under an arrangement of a proportion of the excessive lump sum found by applying the formula

V/AV

Where V = is the value of the uncrystallised lump sum rights under the arrangement

AV = is the total value of the uncrystallised lump sum rights under all the arrangements in respect of the employment being pensioned.

VUR

Paragraphs 33(1) and 8(5) schedule 36 paragraphs 33(2, 4, 6, 8 and 9) and 9(3) schedule 36 Finance Act 2004

VUR is the total value of the uncrystallised pension rights determined under paragraph 8 Schedule 36 for each arrangement under the scheme. Where the total value of the pension rights was more than the HMRC maximum permitted pension, an appropriate adjustment is made to the value of the pension rights under each arrangement. The adjustment is a deduction from the value of the pension rights in an arrangement of a proportion of the excessive pension rights found by applying the formula

V/AV

Where V = is the value of the uncrystallised pension rights under the arrangement

AV = is the total value of the uncrystallised pension rights under all the arrangements in respect of the employment being pensioned.

Four examples follow showing how excess benefits impact on scheme specific lump sum protection in a variety of different circumstances.

Example 1 - lump sum rights exceeded HMRC limits: same employment, more than one scheme with one arrangement in each

Asif had pension and lump sum rights for a single employment on 5 April 2006. His total pension rights were £210,000 and total lump sum rights were £60,000. These rights were held in three schemes, in a single arrangement under each scheme.

Asif’s maximum permitted lump sum for the employment under HMRC limits was calculated as £54,000. So his lump sum rights exceeded HMRC limits by £6,000. His maximum permitted pension under HMRC limits was greater than £210,000.

Therefore VULSR must be adjusted whilst VUR remains the same.

The position before adjustment was as follows

Scheme 1 - pension rights of £60,000; lump sum £15,000; lump sum percentage 25%

Scheme 2 - pension rights of £60,000; lump sum £20,000; lump sum percentage 33.33%

Scheme 3 - pension rights of £90,000; lump sum £25,000; lump sum percentage 27.78%

The reduction in Asif’s lump sum rights from £60,000 to £54,000 must be apportioned amongst the three schemes. The legislation specifies that the apportionment is as follows.

Scheme lump sum - (excess lump sum x scheme lump sum/total lump sums)

So for scheme 1 the apportionment would be

£15,000 - (£6000 x £15,000/£60,000) = £13,500

After adjustment, Asif’s lump sum percentage from each of the three schemes becomes

Scheme 1 - pension rights of £60,000; lump sum £13,500; scheme percentage 22.5%

Scheme 2 - pension rights of £60,000; lump sum £18,000; scheme percentage 30%

Scheme 3 - pension rights of £90,000; lump sum £22,500; scheme percentage 25%

So after the required adjustment, only the rights in Scheme 2 qualify for protection, as the lump percentage exceeds 25% of the uncrystallised pension rights in that scheme.

Rights in schemes 1 and 3 may be taken at 25% because the normal rules for pension commencement lump sums in Schedule 29 Finance Act 2004 apply to the rights under those two schemes.

Example 2 - lump sum rights exceeded HMRC limits: same employment, three schemes with one arrangement in each

Mike had benefits in 3 money purchase arrangements for his single employment. The total fund value was £645,000 split as follows.

Scheme A = £120,000

Scheme B = £500,000

Scheme C = £25,000

All schemes provided lump sums by commutation. Scheme A provided a lump sum of 3/80ths salary for each year of service. Schemes B and C both potentially provided the maximum permitted lump sum that could have been paid under HMRC limits at 5 April 2006. The lump sum entitlement under the schemes on that date were as follows

Scheme A = £110,000 (91.67%)

Scheme B = £150,000 (30%)

Scheme C = £25,000 (100%)

Mike can only protect what he is actually entitled to. The funds in scheme C were less than Mike’s HMRC maximum permitted lump sum, but as there was only £25,000 actually available to provide benefits, his lump sum entitlement is the fund value of £25,000.

Mike’s HMRC maximum benefits were a pension of £100,000 a year and a lump sum of £150,000. The total scheme funds cannot provide excessive pension benefits, but the total lump sum entitlement of £285,000 was £135,000 more than the HMRC maximum permitted lump sum. The £135,000 excess is apportioned across all 3 schemes using the formula

Scheme lump sum - (excess lump sum x scheme lump sum /total lump sums)

Scheme A = £110,000 - (£135,000 x £110,000/£285,000) = £57,895

Scheme B= £150,000 - (£135,000 x £150,000/£285,000) = £78,947

Scheme C= £25,000 - (£135,000 x £25,000/£285,000) = £13,158

This gives lump sum rights apportioned between the schemes as follows

Scheme A = £57,895 (48.25%)

Scheme B = £78,947 (15.79%)

Scheme C = £13,158 (52.63%)

Schemes A and C have protected lump sum rights. As the adjusted lump sum rights under scheme B are now below 25%, scheme B is not protected. The normal lump sum rules under paragraphs 2 and 3 Schedule 29 Finance Act 2004 apply to scheme B.

Example 3 - lump sum rights exceed HMRC limits: more than one employment

Jenny was a member of three schemes in respect of two different employments. On 5 April 2006 her benefit rights were as follows.

Scheme 1 - pension rights = £25,000; lump sum = £15,000 (60%)

Scheme 2 - pension rights = £80,000; lump sum = £25,000 (31.25%)

Scheme 3 - pension rights = £100,000; lump sum = £27,000 (27%)

Schemes 1 and 2 both relate to employer Z. Scheme 3 relates to employer C. All the pensions provided were within the HMRC maximum permitted pension. However, the maximum permitted lump sum for employer Z is £30,000 and for employer C £25,000.

The lump sum rights of £40,000 in respect of employer Z must be reduced and apportioned as follows

Scheme 1: £15,000 - (£10,000 x £15,000/£40,000) = £11,250

Scheme 2: £25,000 - (£10,000 x £25,000/£40,000) = £18,750

The lump sum rights in respect of employer C is the lower HMRC maximum-permitted lump sum value of £25,000.

This means Jenny’s adjusted entitlements on 5 April 2006 are

Scheme 1 - pension rights = £25,000; lump sum = £11,250 (45%)

Scheme 2 - pension rights = £80,000; lump sum = £18,750 (23.44%)

Scheme 3 - pension rights = £100,000; lump sum = £25,000 (25%)

Only scheme 1 has lump sum rights of more than 25%, so this is the only scheme that can be protected. Schemes 2 and 3 will pay out lump sums in accordance with the normal pension commencement lump sum rules in Schedule 29.

Example 4 - where it is the pension not lump sum rights that exceed HMRC limits

An adjustment to the value of an individual’s uncrystallised pension rights also triggers a re-calculation of the lump sum percentage available in multiple schemes.

Lesley had pension and lump sum rights in two schemes for a sole employment on 5 April 2006. She had total pension rights of £200,000 and her lump sum rights were £44,000. Her rights were held in a single arrangement under each scheme. The £44,000 was less than her maximum permitted lump sum under HMRC limits but her maximum permitted pension under HMRC limits was valued at £160,000.

The position before adjustment was as follows

Scheme A - pension rights of £80,000; lump sum £20,000; lump sum percentage 25%

Scheme B - pension rights of £120,000; lump sum £24,000; lump sum percentage 20%

The reduction in Lesley’s pension rights from £200,000 to £160,000 must be apportioned between the two schemes.

In scheme A, the value of the pension rights is adjusted as follows, £80,000 - (£40,000 x £80,000/£200,000) which gives a figure of £64,000.

In scheme B, the value of the pension rights is adjusted as follows, £120,000 - (£40,000 x £120,000/£200,000 which gives a figure of £96,000.

After adjustment, Lesley’s lump sum percentages from the two schemes become

Scheme A - pension rights of £64,000; lump sum £20,000; lump sum percentage 31.25%

Scheme B - pension rights of £96,000; lump sum £24,000; lump sum percentage 25%

So after the required adjustment, the rights in Scheme A qualify for protection, as the lump sum percentage exceeds 25% of Lesley’s uncrystallised pension rights in that scheme.