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HMRC internal manual

Pensions Tax Manual

The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: each of the benefit crystallisation events (BCEs) in detail: BCE 3 increase to a scheme pension in payment

Glossary PTM000001
   

 

Level of pension increases caught by BCE 3
Excepted circumstances
Anti-avoidance rule for excepted circumstances provisions
Pension entitlements that are not covered by BCE 3
Abatement of a scheme pension under a public service pension scheme
The threshold annual rate
The threshold annual rate - the relevant percentage rate
The threshold annual rate - the relevant indexation percentage
The threshold annual rate - increases not exceeding £250
The threshold annual rate - rounding up
The threshold annual rate - an increase awarded within 12 months of becoming entitled to a scheme pension
The permitted margin
The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006
The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006 - calculation A
The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006 - calculation B
Example of how calculation A and B are worked out where entitlement to the scheme pension arose on or after 6 April 2006 and BCE 3 occurs on or after 6 April 2008
The permitted margin where entitlement to the scheme pension arose before 6 April 2006
Calculating the capital crystallised value of any pension increase beyond the permitted margin (‘XP’)
Prevention of overlap under BCE 3 when calculating ‘XP’ - further BCE 3 occurs on or after 10 October 2007
Ill-health scheme pension ceases or reduces (BCEs 2 and 3)
Retail Price Index (RPI) tables

Section 216(1)-BCE3, Finance Act 2004

Paragraphs 2, 6, 8, 10, 11 and12 Schedule 32 Finance Act 2004

See PTM088100 for an overview of the benefit crystallisation events (BCEs) and the lifetime allowance.

Level of pension increases caught by BCE 3

If an increase in a scheme pension in payment exceeds a certain level, a lifetime allowance test is triggered through BCE 3. An amount is regarded as crystallising for lifetime allowance purposes when it exceeds both of:

  • the threshold annual rate, and
  • the permitted margin.

The threshold annual rate is exceeded where the difference between:

  • the rate of scheme pension in payment a year earlier, and
  • the new current rate of scheme pension,

Is more than the greatest of:

  • RPI
  • 5 per cent of the rate of scheme pension in payment a year earlier and
  • £250.

In some circumstances the 5 per cent figure may be set at a different level for a particular scheme (see below).

Where there has already been an increase to the pension within the last 12 months, it is still the rate of pension after the current increase (which will include the previous increase, which will itself have been tested earlier) that is compared to the old rate of pension to see if the threshold annual rate is exceeded.

If the pension increase occurs in the first year of payment of the pension, the threshold annual rate is the greatest of the 3 forms of increase as above applied to the rate of pension at the start of the pension (see below).

The permitted margin is in effect a notional ongoing cost-of-living increase since the scheme pension came into payment, and is measured as an annual rate of increase of the greater of 5 per cent or RPI (although in some circumstances the 5 per cent figure may be set at a different level for a particular scheme (see below).

The intention is to identify only real value increases in pension benefits where these are funded directly by the scheme. Schemes that simply provide for annual increases linked to RPI or a set percentage of no more than 5 per cent (or - unusually -whatever other percentage has been agreed between the scheme administrator and HMRC for that particular scheme) will not be concerned with this BCE.

If an increase does not exceed the threshold annual rate, no test will be necessary to determine if the increase has gone beyond the permitted margin, as the BCE 3 only occurs if both of these are exceeded.

Where the threshold annual rate is exceeded, any excess (‘XP’) of a pension increase beyond the permitted margin is converted to a capital value in a similar way to the crystallisation of a scheme pension at outset through BCE 2, with the resulting figure representing the amount that crystallises at the point of increase.

The threshold annual rate is explained below.

The effective date of this BCE is the date on which the member becomes entitled to the payment of the increased pension. PTM088200 explains what is meant by entitlement in more detail.

There are circumstances where a scheme pension in payment may be increased beyond the permitted margin without giving rise to BCE 3. These are referred to in the legislation as the excepted circumstances.

An increase to a scheme pension after age 75

Increases made after the member’s 75th birthday are still tested through BCE 3. It is the only form of BCE that can apply after the member’s 75th birthday.

Pensions that came into payment before 6 April 2006

Pensions that came into payment before 6 April 2006 can also create a BCE 3 if they come within the scheme pension definition on or after 6 April 2006. This is covered further below and also at PTM088300.

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Excepted circumstances

Section 141 and paragraph 10 Schedule 32 Finance Act 2004

Paragraph 44 Schedule 10 Finance Act 2005

A registered pension scheme that overall has 50 or more pensioner members (that is, persons who are in receipt of pensions directly under the scheme including a scheme pension or dependants’ scheme pension) may increase some or all of those scheme pensions being paid to members beyond the threshold annual rate and the permitted margin without triggering a lifetime allowance test through BCE 3.

This is provided:

  • the same rate of increase is applied at the same time to all the scheme pensions that are in payment in respect of a particular class of pensioner members under the scheme; and
  • there are at least 20 pensioner members in that particular class.

Such a class of pensioner members might include members who are in receipt of a scheme pension and members who are in receipt of a dependants’ scheme pension. The requirement is that all of the scheme pensions (not necessarily the dependants’ scheme pensions) being paid under that class must be increased at that same rate. This means that if there are fewer than 20 pensioner members receiving scheme pensions in that class, because the remainder of the pensioner members in that class are receiving a dependants’ scheme pension, the requirement will still be regarded as being met.

This exception covers large schemes that might give across the board discretionary augmentation to all their members with pensions in payment, or give increases to different groups of pensioner members at different times. In effect this means that if particular pensioner members are awarded increases in circumstances that are outside of this exception, tests against the threshold annual rate and, if the threshold annual rate is exceeded, the permitted margin to determine if there is a BCE 3 are carried out only in respect of those particular members.

This applies whether the increased rate is given as a fixed percentage or a fixed absolute increase, e.g. everyone gets £500 extra a year. It can also apply to a fixed percentage or a fixed absolute increase on a part of the pension for which an increase is being given.

Where a scheme provides for a pension commencement lump sum by way of commutation and a pension increase is a fixed percentage applied to the pre-commutation level of pension, the actual increase to the pension in payment will vary according to how much if any of the pension has been commuted. The increases will not be at the same rate so the increase will not occur in excepted circumstances. This is because BCE 3 occurs by reference to the scheme pension crystallised through BCE 2 (see PTM088620) and not the pre-commutation level of that pension. It would only be possible to fall within the excepted circumstances if all the pensioner members within a class of more than 20 pensioner members commuted the same percentage of their pension so that the same rate of increase in the pension applies to them all.

Provided the percentage rate of increase is the same for all the pensioner members in a class, the increase may still be given in excepted circumstances even though the actual increases applied vary because of DWP rules, for example increases limited to rights in excess of guaranteed minimum pension (GMP). The same principle applies where it is the scheme rules that limit the increase to a proportion of the pension, say an increase limited to that part of the pension attributable to service before or after a particular cut-off date.

But any pension increase which is in some way personalised for the individual, for example it occurs on a birthday of the member, is unlikely to meet the conditions in the second paragraph of this page unless similar increases are also being applied and at the same time for a sufficient number of people. It is therefore likely to be the case that an increase to a pension resulting from a revaluation of contracting-out rights, such as a ‘step-up’ for GMP, based on the particular circumstances of a single member, will not meet the conditions.

For an increase to be given ‘at the same time’ for all of the members within a particular class of pensioner members means that all of the members in that class get entitlement to the scheme pension at the increased rate with effect from the same date even though the actual payment of the pensions at that increased rate might not start at the same time. For example, there are 20 pensioner members in a particular class and all of them are awarded the same rate of increase on 1 June 2008. Of that class, 15 receive their pensions at the increased rate on 1 June 2008 but the other 5 get their pensions at the increased rate on 1st July 2008 together with an arrears payment to reflect that, for those 5 members, their entitlement to pension at the increased rate actually ran from 1 June 2008.

A “class of pensioner member” can be determined at the time of each increase and can be interpreted flexibly but within its natural meaning. It can include some, or all, pensioner members of the scheme. It need not be confined to a particular category of membership under the scheme rules. It is possible for a member to be in a different class at the time different increases are applied, but this must be subject to the anti-avoidance rule described below.

Where a one-off increase is offered to all of a scheme’s pensioners under a pension increase exchange exercise but the increase for each pensioner is calculated by reference to their age and gender, this is a personalised increase. This is so even if the increases are all calculated using the same formula.

However, where an offer is accepted by at least 20 pensioner members who will receive the same rate of personalised increase, the “excepted circumstances” may apply as the pensioners concerned may be “a class of pensioner member”. For example, the scheme rules may permit the scheme administrator and/or the trustees to define those pensioner members accepting the same percentage increase under a pension increase exchange offer as a separate class of pensioner member for this purpose. Provided there are at least 20 pensioner members in the class the excepted circumstances may apply.

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Anti-avoidance rule for excepted circumstances provisions

When a scheme pension in payment is increased in the excepted circumstances described above there is no lifetime allowance test through BCE 3.

The excepted circumstances could be open to manipulation for an individual wanting to avoid a lifetime allowance test under BCE 3 by arranging for that individual to be a pensioner member of more than one class of pensioner members under a particular pension scheme and then receiving increases in respect of each class that, in relation to each class, satisfy the excepted circumstances conditions.

To overcome this possible manipulation there is an anti-avoidance rule, which applies in the following way:

  • the rate of an individual pensioner member’s scheme pension is increased in excepted circumstances and so no BCE 3 test is required - the first excepted increase
  • before the end of the period of 12 months beginning with the date of the first excepted increase, the annual rate of the individual’s pension is increased again one or more times in excepted circumstances (the subsequent increase or increases) but, each time, under a different class of pensioner membership to which the first excepted increase related (the new class or classes), and
  • the purpose, or one of the main purposes, for the individual being included in the new class or classes is to increase the annual rate of the individual’s pension without BCE 3 occurring.

Where these circumstances apply the subsequent increase (or each subsequent increase) is not an increase in excepted circumstances. Thus a test against the threshold annual rate and, if necessary, the permitted margin would be required to determine whether a BCE 3 has occurred in relation to the subsequent increase (or each subsequent increase).

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Pension entitlements that are not covered by BCE 3

BCE 3 is the only BCE that deals with an increase in a pension in payment, and only scheme pensions are covered. This is because increases in other forms of pension provision (annuities and drawdown) are dealt with for lifetime allowance purposes at the outset, under BCE 1 and BCE 4.

Pensions that represent unauthorised member payments

Where a scheme pension entitlement arises under a registered pension scheme before the normal minimum pension age and the ill-health condition is not met then unless the member has a protected pension age, that pension is not within the definition of a scheme pension. It is taxed as an unauthorised member payment.

Until the pension stops being an unauthorised member payment, that pension and any increases to it, are not tested for lifetime allowance purposes.

Once the member reaches normal minimum pension age, the scheme pension is tested under BCE 2. From then on any increases to that pension are potentially BCE 3s.

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Abatement of a scheme pension under a public service pension scheme

Paragraphs 9A, 10A(9), 11(8) and 12(4) Schedule 32 Finance Act 2004

Paragraphs 8(3) to (6) Schedule 10 Finance Act 2005

Where the rate of scheme pension paid under a public service pension scheme is initially reduced through abatement (because that individual is still in the employment of the relevant public service - see PTM062300, the effects of that abatement are ignored. This applies when considering whether any future increase in the annual rate of that scheme pension has gone beyond the threshold annual rate (including where the scheme pension is increased within the first 12 months) or the permitted margin.

The legislation ignores the level of abatement applied at the time the individual first became entitled to the scheme pension when calculating the initial annual rate for ‘XP’ purposes. This ensures that when the pension returns to its full level of entitlement following the end of the abatement period the individual is not penalised unfairly, as the threshold annual rate and the permitted margin measure are applied to the full potential entitlement, not the initially lower abated amount actual paid.

Example

Kevin becomes entitled to a scheme pension of £10,000 per annum under a public service pension scheme. This pension entitlement is increased every year in line with RPI. But Kevin only receives £5,000 per annum to start with due to his continued employment with that public service.

Two years later Kevin leaves employment and his pension is returned to the full entitlement, which is now worth £11,000. There is no BCE as the pension increase was within the threshold annual rate. This is because the calculation to find out if the threshold annual rate had been exceeded is based on higher (unabated) pension of £10,000 when the first RPI increase is given. If the timing of the annual RPI increases meant that another RPI increase had been given before Kevin’s pension is returned to his full (re-valued) entitlement of £11,000, again, the calculation for the threshold annual rate would have been based on the higher (unabated) pension of £10,000 plus the first RPI increase.

As the threshold annual rate has not been exceeded a calculation to determine whether of not the permitted margin has been exceeded, based on the pension since it started, would not have to be undertaken. But if it did, the initial pension being considered would also be the higher (unabated) pension of £10,000.

This applies equally to both scheme pensions that commenced before and on or after 6 April 2006 (so is relevant when considering the threshold annual rate).

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The threshold annual rate

Paragraph 10A Schedule 32 Finance Act 2004

If the rate of a scheme pension in payment to a pensioner member is increased other than in excepted circumstances described earlier, the next step to determine whether a lifetime allowance test is needed through BCE 3 is to determine whether the increase exceeds the ‘threshold annual rate’.

To determine the threshold annual rate, first:

  • take the date on which entitlement to the scheme pension at the increased annual rate arose - the current date
  • go back to what was the previous anniversary date 12 months earlier than the current date - the previous date
  • determine the annual rate of the scheme pension at the previous date, and
  • determine the annual rate of the scheme pension at the current date.

If the difference between the annual rate of the scheme pension at the previous date and the current date does not exceed the greatest of (as rounded up):

  • the relevant percentage rate,
  • the relevant indexation percentage, and
  • £250 (or such other amount that may be made by an order of HM Treasury).

Then the increase at the current date has not exceeded the threshold annual rate and no test is required under BCE 3.

If the date of increase is 29th February the date of increase must instead be taken as 28th February for the purpose of comparing with the anniversary date 12 months earlier.

Also, as described below, when an increase is awarded to a scheme pension and that pension only came into payment less than 12 months before the date of the increase. For example, an increase is given on 1 June 2015 to a scheme pension where entitlement started on 2 June 2014.

The threshold annual rate test applies equally to both scheme pensions that commenced before, on or after 6 April 2006. For details about pre commencement pensions, see PTM088300.

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The threshold annual rate - the relevant percentage rate

One of the tests to decide whether the threshold annual rate has been exceeded is to determine if the increase to a scheme pension in payment has exceeded the ‘relevant percentage rate’.

The relevant percentage rate is 5 per cent unless the scheme administrator has agreed with HMRC the use of a ‘relevant valuation factor’ (RVF) that is greater than 20 for valuing the relevant scheme pensions derived from that scheme for lifetime allowance purposes through BCE 2. Where such a non-standard RVF has been agreed, HMRC will at the same time agree the relevant percentage rate that should be applied here for BCE 3 purposes. Then the relevant percentage rate for that scheme would be greater than 5 per cent.

Also, a further amount can be added on the increase by reference to the relevant percentage rate to allow for rounding up.

Example

Arnold is receiving a scheme pension of £10,000 per annum on 31 May 2015. On 1 June 2015 he becomes entitled to receive his pension at an increased annual rate of £10,500 per annum. On 1 June 2014 the annual rate of Arnold’s pension was £10,000 per annum. Despite the increase to Arnold’s pension being greater than £250 (see below), the threshold annual rate has not been exceeded as the annual rate of Arnold’s pension on 1 June 2015 has not exceeded 5per cent (£10,500 - £10,000 = an increase of £500 or 5per cent) and no BCE 3 test is required in respect of that increase.

On 1 September 2015 the annual rate of Arnold’s pension is increased again from £10,500pa to £10,700pa. On 1 September 2014 his annual rate of pension was £10,000. This level of increase since that date is assumed to have exceeded the level of increase under the relevant indexation increase (see below). The threshold annual rate has been exceeded this time as the increase has exceeded both £250 and 5 per cent (£10,700 - £10,000 = an increase of £700 or 7 per cent) and so the test against the permitted margin (as described below) is required to determine whether there will be a BCE 3 in respect of this increase.

For the purpose of this example it is assumed that no rounding up has occurred and no agreement has been given to the use of a RVF of greater than 20.

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The threshold annual rate - the relevant indexation percentage

One of the tests to decide whether or not the threshold annual rate has been exceeded is to determine if the increase to a scheme pension in payment has exceeded the ‘relevant indexation percentage’.

The relevant indexation percentage is the increase in the RPI for the period which ended with the ‘reference month’ and began with the same calendar month as the reference month in the preceding year.

The ‘reference month’ is any month chosen by the scheme administrator that is within the period of 12 months ending with the month in which the pensioner member became entitled to the scheme pension at the increased rate. So for a pension increase in December 2014 the scheme administrator may select a month as far back as January 2013 as the reference month.

The percentage should be rounded up to one decimal place as this is consistent with how the RPI tables work. For instructions on how to find the RPI tables on the internet, see Retail Price Index (RPI) tables at the bottom of this page.

The relevant indexation percentage can never be lower than 0 per cent.

Also, a further amount can be added on the increase by reference to the relevant indexation percentage to allow for rounding up.

Example

Arnold is in receipt of a scheme pension of £10,000 pa on 31 May 2008. On 1 June 2008 Arnold becomes entitled to receive his pension at an increased annual rate of £10,640pa. Despite the increase to Arnold’s pension being greater than £250 and the ‘relevant percentage rate’ (Arnold’s pension has been increased by more than 5per cent, the threshold annual rate has not been exceeded as the annual rate of Arnold’s pension on 1 June 2008 has not exceeded the ‘relevant indexation percentage’.

To determine if the relevant indexation percentage has been exceeded, the increase in the rate of Arnold’s scheme pension was measured by reference to the increase in the RPI between April 2007 and April 2008 - April 2008 being the ‘reference month’ chosen by the scheme administrator. The RPI figures for these two months are 190 and 202 respectively (note - these figures are estimated and used for illustrative purposes only). The percentage rise in the RPI over the period is calculated as follows:

202/190 x 100 - 100 = 6.4 per cent (rounded up). This is the ‘relevant indexation percentage’.

6.4 per cent of £10,000 = £640.

Applying the relevant indexation percentage to Arnold’s scheme pension of £10,000 pa gives an amount of £10,640 (£10,000 + £640). As Arnold’s pension has been increased to this same amount the threshold annual rate has not been exceeded and no BCE 3 test is required in respect of that increase.

Allowing the scheme administrator to choose the reference month allows for RPI increases to be awarded in a particular month that is based on an earlier period as the very latest RPI figures may not be available for the month in which the increase is awarded. For example, if the pension increase is awarded every June the RPI figure for that June may not be available and so the increase can be based on an earlier period, say from April to April, provided the chosen reference month ends within the period of 12 months ending with the month in which the increase to the scheme pension occurs.

The reference month can be chosen each time the threshold annual rate is tested against and there does not need to be a consistent period between it and the month in which the increase is awarded.

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The threshold annual rate - increases not exceeding £250

One of the tests to decide whether or not the threshold annual rate has been exceeded is to determine if the increase to a scheme pension in payment has exceeded £250.

Also, a further amount can be added on to an increase not exceeding £250 to allow for rounding up (see heading below).

Example

Arnold is in receipt of a scheme pension of £4,000 per annum on 31st May 2008. On 1 June 2008 Arnold becomes entitled to receive his pension at an increased annual rate of £4,225 per annum. On 1 June 2007 the annual rate of Arnold’s pension was £4,000 per annum.

The increase of £225 means that Arnold’s scheme pension has increased by more than 5 per cent (an increase of 5 per cent being £200) which means that the ‘relevant percentage rate’ part of the threshold annual rate test is exceeded.

For the purpose of this example it has been taken that the biggest increase that could be given by reference to the RPI is £150 which means that the ‘relevant indexation percentage’ part of the threshold annual rate test is exceeded.

However, the threshold annual rate has not been exceeded as the increase to the annual rate of Arnold’s pension on 1 June 2008 has not exceeded £250 (£4,225 - £4,000 = an increase of £225) and no BCE 3 test is required in respect of that increase.

On 1 September 2008 the annual rate of Arnold’s pension is increased again from £4,225 per annum to £4,394 per annum (an increase of £169 or 4 per cent). On 1 September 2007 Arnold’s annual rate of pension was £4,000.

Whilst the increase of £169 on 1 September 2008 represented a 4 per cent increase the ‘relevant percentage rate’ part of the threshold annual rate test is still exceeded as Arnold’s pension has increased by more than 5 per cent when compared to the rate of his pension on 1 September 2007 (£4,394 - £4,000 = £394 or an increase of 9.85 per cent).

Again, for the purpose of this example it has been taken that the ‘relevant indexation percentage’ part of the threshold annual rate test is also exceeded.

Although the increase on 1 September 2008 is £169 the threshold annual rate has been exceeded this time as, along with relevant percentage rate and the relevant indexation percentage, the increase has also exceeded £250 when Arnold’s new rate of pension is compared with the rate on 1 September 2007 (£4,394 - £4,000 = an increase of £394).

A test against the permitted margin is required to determine whether or not there will be a BCE 3 in respect of this increase.

Also, for the purpose of this example the scheme administrator has not rounded up any of the increases to the scheme pension.

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The threshold annual rate - rounding up

Basically, the threshold annual rate is not exceeded if a scheme pension in payment is increased by no more than the greatest of:

  • 5 per cent (or such greater percentage if a relevant valuation factor greater than 20 is used),
  • Retail prices index (RPI), and
  • £250.

Provided no other increase has been given in respect of the pension within the last 12 months.

Also, it is possible to give a further increase to allow for the increased rate of pension to be rounded up to the next greatest amount which:

  • gives an amount in whole pounds (£) when divided by 12 - for scheme pensions paid monthly, or
  • gives an amount in whole pounds (£) when divided by 52 - for scheme pensions paid weekly.

Example

Arnold is receiving a scheme pension and is entitled to receive annual increases to it based on the RPI and his pension is increased from £10,000 pa to £10,630 pa. As Arnold’s pension is paid monthly this would mean that his monthly instalments for the next 12 months would be £885.83 (£10,630/12).

However, instead of receiving the pension at the increased rate of £10,630, Arnold’s pension is actually increased to a rate of £10,632 to allow for Arnold’s monthly instalment of pension to be paid in whole pounds (£) of £886 per month (£10,632/12). As Arnold’s pension has been increased to the next greatest amount from the RPI increase to allow for Arnold’s pension to be paid monthly in whole pound (£) amounts the threshold annual rate has not been exceeded and no lifetime allowance test through BCE 3 is needed.

It should be noted that the increase in RPI gives the greatest amount of increase over 5 per cent (and is assumed to be greater than the percentage if a relevant valuation factor greater than 20 is used) and £250.

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The threshold annual rate - an increase awarded within 12 months of becoming entitled to a scheme pension

One of the features of the ‘threshold annual rate’ test is that when the annual rate of a scheme pension in payment is increased on a particular date (the increase date) that increased annual rate is compared with the annual rate of pension that was being paid on what was the previous anniversary date 12 months earlier than the increase date.

For example, if a pensioner member receiving a scheme pension becomes entitled to receive that pension at a higher rate on 1st June 2015, the increased annual rate of pension is compared with the annual rate of pension that the member was entitled to on 1st June 2014 as part of the threshold annual rate test.

However, it is possible that the provisions of a particular registered pension scheme might mean that annual increases are awarded to all scheme pensions in payment at the same time and so a pensioner member might receive an increase within the next 12 months of first becoming entitled to the payment of a scheme pension. Such a member would not have been in receipt of a scheme pension on the previous anniversary of the increase date.

The threshold annual rate test, therefore, allows for the possibility that increases might be awarded to scheme pensions that have been in payment for a period of less than 12 months at the time the increase is awarded. It does this by treating the date that the member first became entitled to the pension as if it were the previous anniversary date of the increase date and then increasing the pension from that start date by the greatest of:

  • the relevant percentage rate,
  • the relevant indexation percentage , and
  • £250 (or such other amount that may be made by an order of HM Treasury).

As rounded up.

Note that a pro-rata of the relevant percentage rate (5 per cent or such greater amount if a relevant valuation factor of greater than 20 has been agreed) is not required when the member has been in receipt of the pension for a period of less than 12 before the increase is awarded. This is in contrast to the test for the ‘permitted margin’ when an apportionment is required (see heading below for more details).

Example 1

Arnold becomes entitled to his scheme pension of £10,000 pa on 2 June 2007. On 1st June 2008 Arnold’s pension is increased along with the scheme pensions in payments for all of the other pensioner members of the scheme. All pensions are increased by £250. Arnold becomes entitled to receive his pension at an annual rate of £10,250 pa (£10,000 + £250).

Arnold was not entitled to any payment of scheme pension on 1 June 2007 - what was the previous anniversary date of the increase date of 1 June 2008. Instead, the increased annual rate of Arnold’s pension is compared with the pension Arnold was entitled to when he first became entitled to actually receive it - £10,000 pa on 2 June 2007. The threshold annual rate has not been exceeded as the annual rate of Arnold’s pension on 1 June 2008 has not exceeded £250 (£10,250 - £10,000 = an increase of £250) and no BCE 3 test is required in respect of that increase.

For the purpose of this example it is assumed that increases by reference to the relevant percentage rate and the relevant indexation percentage would have given lesser amounts of increases and that no rounding up has occurred.

Example 2

Arnold first becomes entitled to his scheme pension of £10,000pa on 1 December 2007. On 1 June 2008 Arnold’s pension is increased along with the scheme pensions in payment for all of the other pensioner members of the scheme. All pensions are increased by 5 per cent. Arnold becomes entitled to receive his pension at an increased annual rate of £10,500pa (£10,000 + 5 per cent).

Arnold was not receiving any scheme pension on 1 June 2007 - the previous anniversary date of the increase date of 1 June 2008. Instead, the increased annual rate of Arnold’s pension is compared with the pension Arnold was entitled to when he first became entitled to actually receive it - £10,000pa on 1 December 2007. Despite the increase exceeding £250, the threshold annual rate has not been exceeded as the annual rate of increase in Arnold’s pension on 1 June 2008 has not exceeded 5 per cent (£10,500 - £10,000 = an increase of 5 per cent) and no BCE 3 test is required in respect of that increase. Even though Arnold’s pension has only been in payment for 6 months, no pro-rata of the 5 per cent allowance is required.

On 1 September 2008 the annual rate of Arnold’s pension is increased again from £10,500pa to £11,025pa. The latest increase date is 1 September 2008 but on the previous anniversary date of the latest increase date (1 September 2007) Arnold was not entitled to receive his pension. Instead, the increased annual rate of Arnold’s pension is compared with the pension Arnold was entitled to when he first became entitled to actually receive it - £10,000pa on 1 December 2007. The threshold annual rate has been exceeded this time as the increase has exceeded 5 per cent (£11,025 - £10,000 = an increase of £1,025 or 10.25 per cent) and so the test against the permitted margin is required to determine whether or not there will be a BCE 3 in respect of this increase.

For the purpose of this example it is assumed that increases by reference to the relevant indexation percentage would have given lesser amounts of increase and that no rounding up has occurred.

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The permitted margin

Whether or not the permitted margin has been exceeded need be considered only if there is an increase to a scheme pension in payment other than in excepted circumstances (see above) and the increase exceeds the ‘threshold annual rate’. If the increase to the pension does not exceed the threshold annual rate there is no lifetime allowance test through BCE 3.

If the threshold annual rate has been exceeded the way the permitted margin is calculated at the point of pension increase will vary depending on whether the initial entitlement to the scheme pension being increased arose on or after 6 April 2006, or before that date.

The permitted margin is not applied to an individual year in isolation but an ongoing test from the point when entitlement to the pension first arose. Staggered, one-off or uneven increases to a scheme pension in payment are catered for by giving credit for years where increases below the permitted margin measure were awarded by the scheme.

How the excess (XP) is calculated, and an example of how the permitted margin test is applied over a period of years are explained below.

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The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006

If the pension entitlement arose on or after 6 April 2006, the permitted margin by which a scheme pension may be increased each year without triggering BCE 3 is calculated by applying the greater of two figures to the annual rate of pension the member first became entitled to.

These are referred to in the legislation as ‘Calculation A’ and ‘Calculation B’.

Calculation A is a set annual percentage referred to in the legislation as the ‘relevant annual percentage’. This is set in the legislation at the rate of 5 per cent per annum, but may be different in certain circumstances.

Calculation B is a measure of the retail price index (RPI) called in the legislation the ‘relevant indexation percentage’. How the relevant indexation percentage is calculated depends on whether the BCE 3 occurs on, or after, 6 April 2008 or before that date.

The permitted margin of increase is calculated by applying the higher of the two figures to the initial rate of scheme pension entitlement - calculation A or calculation B.

Calculation A and calculation B are explained in examples below. There’s also an example of how the calculations are worked out.

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The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006 - calculation A

Paragraph 11(3) and (4) Schedule 32 Finance Act 2004

Under calculation A, the starting scheme pension, as measured initially through BCE 2, is increased each year up to the point of increase by what is called the ‘relevant annual percentage rate’.

This will be 5 per cent per annum, unless the scheme has agreed with HMRC the use of a relevant valuation factor (RVF) that is greater than 20 for valuing all scheme pensions derived from that scheme for lifetime allowance purposes through BCE 2. Where such a non-standard RVF has been agreed HMRC will at the same time agree the relevant annual percentage rate that should be applied for BCE 3 purposes.

The relevant annual percentage is applied on a compound basis for the whole intervening period between the point entitlement to the scheme pension initially arose to the point the increase concerned is being applied. There will be many instances where the intervening period will not be measured in whole years. In such cases, the relevant annual percentage is applied on a pro-rata basis by measure of months, counting the months the two points occur in as completed months. This is in contrast to the ‘relevant percentage rate’ that forms part of the threshold annual rate calculation. In that situation a pro-rata basis is not required when considering a 5 per cent increase (or such greater amount if a non-standard RVF has been agreed) to a scheme pension that has been in payment for a period of less than 12 months at the time that the increase is awarded.

A similar thing happens when calculating the relevant indexation percentage under calculation B.

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The permitted margin where entitlement to the scheme pension arose on or after 6 April 2006 - calculation B

Paragraphs 11(5) to (7B) Schedule 32 Finance Act 2004

Calculation B undertaken for BCE 3 occurring before 6th April 2008

See the archived manual pages if you need calculation examples for this period.

Calculation B undertaken for BCE 3 occurring on or after 6th April 2008

Under calculation B, the starting pension is increased up to the point of increase to reflect the rise in the RPI over the intervening period. This is the ‘relevant indexation percentage’.

As with calculation A, it is unlikely that the timescales involved will be periods of whole years. RPI figures are published on a monthly basis: the relevant table can be downloaded from the internet (For instructions on how to find the RPI tables on the internet, see Retail Price Index (RPI) tables at the bottom of this page).

The relevant indexation percentage is the increase in the RPI for the period beginning with the ‘base month’ and ending with the ‘reference month’.

The reference month is any month chosen by the scheme administrator that is within the period of 12 months ending with the month in which the pensioner member became entitled to the scheme pension at the increased rate.

The base month is the month which is the same number of months before the month in which the member first became entitled to the payment of the scheme pension as the reference month is before the month in which the pensioner member became entitled to the scheme pension at the increased rate.

Allowing the scheme administrator to choose the reference month allows for the fact that the latest RPI figures would not be available at the time calculation B is being undertaken in respect of a possible BCE 3. For example, if an increase is to be awarded in June 2008 the RPI figure for that June might not be available. If, instead, the chosen reference month is, say, April 2008 (i.e. 2 months before the month of the increase) that would mean that the base month would have to be the month that is two months before the month in which the member first became entitled to the scheme pension.

The example below explains how this works.

The percentage should be rounded up to at least one decimal place (as this is consistent with how the RPI tables work).

The relevant indexation percentage can never be lower than 0 per cent.

It is not essential for the reference month for the permitted margin check to be the same as the reference month for the threshold annual rate.

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Example of how calculation A and B are worked out where entitlement to the scheme pension arose on or after 6 April 2006 and BCE 3 occurs on or after 6 April 2008

John became entitled to a scheme pension of £10,000 per annum on 1 June 2007. This entitlement is tested through BCE 2, with £200,000 crystallising for lifetime allowance purposes.

John’s pension is increased to £10,600 on 5 February 2009.

For the purpose of this example, it is assumed that the increase to John’s pension exceeds the threshold annual rate.

The scheme administrator now needs to be satisfied that the pension has not been increased beyond the permitted margin.

The scheme administrator needs to calculate what the level of annual pension would be after applying the ‘relevant annual percentage rate’ to the starting pension for the intervening period. Counting the starting month and month of increase as full months there are 21 months between the two points. Applying the relevant annual percentage rate of 5 per cent per annum on a pro-rata basis gives the following result for calculation A.

5 per cent increase for the 12 months to 1 June 2008 takes the £10,000 starting annual rate to £10,500.

Increase £10,500 pro-rata by the 5 per cent annual increase measure to cover the 9 months to February 2009. The percentage increase here is 3.75 per cent (9/12 x 5 per cent).

3.75 per cent of £10,500 is £394.

So the permitted margin the pension can be increased to under calculation A is £10,894 (£10,000 + £500 + £394).

The scheme administrator then has to do the same thing but applying the ‘relevant indexation percentage’.

As the RPI index value is not available for the month in which the increase is awarded (February 2009), the scheme administrator chooses December 2008 as the ‘reference month’ (the earliest month that the scheme administrator could have chosen is March 2008) to determine any increase in the RPI since John became entitled to his pension. However, as the reference month (December 2008) is 2 months before the month in which John becomes entitled to his pension at the increased rate (February 2009), the ‘base month’ must be April 2007 as this is the month that is 2 months before the month John became entitled to his pension (June 2007).

The figures for these two months are 190 and 200 (note - these figures are used for illustrative purposes only). The percentage rise in the RPI over the period is calculated as follows:

200/190 x 100 - 100 = 5.3 per cent. This is the relevant indexation percentage.

5.3 per cent of £10,000 = £530.

Applying the relevant indexation percentage to the starting rate of John’s pension (£10,000 per annum) the resulting figure for calculation B is £10,530 (£10,000 + £530). The permitted margin by which John’s pension can be increased to under calculation B is therefore £10,530.

As the resulting figure from calculation A is higher than calculation B, the permitted margin is £10,894 - the figure found under calculation A. So if John’s pension had been increased beyond £10,894 BCE 3 is triggered (with the excess over £10,894 being ‘XP’).

As John’s pension has been increased to a rate of £10,600pa, the increased rate is below the amount found under calculation A (£10,894) the increase is within the permitted margin for John’s pension at the time of the increase in February 2009 and no BCE 3 occurs in respect of that increase.

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The permitted margin where entitlement to the scheme pension arose before 6 April 2006

Paragraph 12 Schedule 32 Finance Act 2004

If the pension entitlement arose before 6 April 2006 the permitted margin is the greater of:

  • a level as calculated in the same way as detailed in the examples above based on calculation A and B, but applied with effect from the date the entitlement to that pension first arose before 6 April 2006, and
  • the amount by which the annual rate of pension would be greater at the point of calculation if that starting entitlement before 6 April 2006 had been increased, year on year, up to that point by the rate of increase specified in the scheme rules as they stood on 5 April 2006. This is referred to in the legislation as ‘P per cent’.

Protection is given to individuals who are entitled to a higher rate of pension increase than that provided through calculation A or B under a scheme in existence at 5 April 2006.

If the rate of annual pension increase specified at 5 April 2006 is no greater than a 5 per cent or RPI rate the permitted margin will be the first measure above (so as if the entitlement had arisen after 6 April 2006, albeit calculation A and B is applied to a starting point before that date).

The measure of P per cent on 5 April 2006 is subject to HMRC rules in force at that time. So the permitted margin, as calculated through P per cent, can never breach the maximum pension permitted through HMRC rules at the time of retirement, re-valued each year by the greater of 3 per cent or RPI (the pre 6 April 2006 cap on increases in pensions in payment).

P per cent, where measured as a year-on-year increase, is again applied on a compound basis (as with calculation A). But P per cent does not need to relate to a year-on-year percentage increase. Rather, the expression of a percentage exists as a common form of comparison with the other forms of increase. We are prepared therefore to accept that increases to a scheme pension which began before 6 April 2006 which may be accepted as falling within P per cent include the following 3 bulleted items. This applies whether the increases are made before, on or after 6 April 2006, but is dependent on the increases being permitted within the scheme’s provisions as at 5 April 2006:

  • an increase to reflect an adjustment to the level of pension in recognition of the revaluation of contracted-out rights, i.e. to a guaranteed minimum pension (GMP)
  • an increase awarded by use of the discretion of the scheme administrator/trustees where such an increase is demonstrably in keeping with the power permitted within the scheme provisions
  • an increase which relates to an element of a pension, for example, a contracted-out element, which does not relate to another element, or where both elements are increased but at different rates.

All the above increases would be subject to the scheme provisions which limited the scheme pension to the pre A Day HMRC benefit limits. But where a pension was paid at the maximum level, or reached such a level following pension increases, it is likely that it could be further increased at the greater of 3 per cent per year or the increase in the RPI. Increases, even where made after 5 April 2006, which do not produce a pension level above the maximum plus 3 per cent/RPI may be accepted as being within P per cent.

In summary, if it can be established that an increase to a scheme pension which started before 6 April 2006 would have been permitted within the scheme provisions as they stood at 5 April 2006, it may be regarded as being within P per cent. It would follow that such an increase would fall within the permitted margin, and does not give rise to a BCE 3.

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Example of the calculation of the permitted margin where entitlement to the scheme pension arose before 6 April 2006

Marilyn became entitled to a pension from an occupational pension scheme on 1 April 2004 starting (after commutation for a tax-free lump sum) at £10,000 per annum. Marilyn’s maximum pension under HMRC rules (after allowance for commutation) was £20,000 per annum.

On 5 April 2006 Marilyn is entitled under the scheme rules to a rate of increase of 6 per cent per annum. This is subject to HMRC maximum benefit limits.

The scheme becomes a registered pension scheme on 6 April 2006, with the ongoing pension becoming a scheme pension.

In March 2007 Marilyn’s pension is being increased. For the purpose of this example, it is assumed that the increase will exceed the threshold annual rate.

The maximum permitted margin Marilyn’s pension can be raised to is the higher of two amounts:

  • (the usual default permitted margin approach) The margin reached if her starting entitlement of £10,000 per annum on 1 April 2004 had been increased by the higher of 5 per cent per annum compound or by RPI to March 2007, or
  • The margin reached if the £10,000 pension had been increased from 1 April 2004 by 6 per cent per annum compound up until March 2007. This is subject to HMRC maximum benefit limits not being exceeded.

With both calculations the revaluation is over the period from April 2004 to March 2007 (36 months, counting the first and last month as a complete month).

Under the first calculation the permitted margin comes out as calculation A (which is higher than the RPI measure through calculation B). If the £10,000 starting entitlement is increased by 5 per cent per annum compound over the 36 month period Marilyn’s pension would be increased to £11,576 per annum. £11,576 per annum is therefore the permitted margin Marilyn’s pension could be increased by to under the first measure.

Under the second calculation the permitted margin is calculated by the same process as through calculation A above, but by reference to an annual percentage increase of 6per cent, as specified in the scheme rules on 5 April 2006 (P per cent). If the £10,000 starting entitlement is increased by 6 per cent per annum compound over the 36 month period Marilyn’s pension would be increased to £11,910 per annum. The figure of £11,910 is then compared with the HMRC maximum pension that applied in respect of Marilyn on 1 April 2004 (£20,000), increased by the maximum allowable under pre 6 April 2006 HMRC rules. The revised maximum pension figure is £21,854 per annum (£20,000 increased by 3 per cent per annum compound for the 36 month period - assuming 3 per cent per annum compound gives a greater increase than the increase in RPI would for the same period). Therefore the amount of £11,910 per annum is the permitted margin Marilyn’s pension could be increased to under the second measure.

If Marilyn’s scheme pension is increased beyond £11,910 in March 2007 the excess (XP) crystallises for lifetime allowance purposes through BCE 3.

Suppose instead that in Marilyn’s scheme rules as at 5th April 2006, there was power (for the Trustees at their discretion or on instruction from the company or under the general benefit augmentation power) to grant additional increases to pensions in payment so long as the resulting pension did not exceed the old HMRC maximum benefit limit. This would mean that the permitted margin is £21,854 pa and any level of pension granted up to this level would not cause any XP and there would be no BCE 3. (It is noted that the administrator may, in this situation, in practice identify a simple “no-less-than figure” for the HMRC limit that demonstrates that there is no BCE 3 without going to the detail of actually calculating the absolute HMRC limit.)

If Marilyn’s pension later becomes increased in May, 2008, the way that the RPI increase is measured can change. For increases on or after 6 April 2008, instead of RPI being measured by reference to the period from the month of the start of the pension to the month of the increase, the scheme administrator can use a different period. The scheme administrator can take any month in the last 12 months ending with the month of the current increase, the reference month, so for example March 2008, so long as the period begins from the same number of months before the month of the start of the pension (the base month) as the reference month is to the month of the current increase. So in this instance, February 2004. So the RPI would be measured from February 2004 to March 2008.

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Calculating the capital crystallised value of any pension increase beyond the permitted margin (‘XP’)

Section 276 and paragraph 13 Schedule 32 Finance Act 2004

Where the increase is already beyond the “threshold annual rate,” the legislation gives a formula for calculating the capital value of any scheme pension increase beyond the permitted margin as well. It provides a notional value of the capital worth of the increased pension beyond that permitted margin. This is done by multiplying the excess increase (XP) by a relevant valuation factor (RVF). This is represented by the formula:

RVF x XP

RVF = the relevant valuation factor

XP = the annual amount the pension in payment has been increased beyond the permitted margin.

The RVF is set at 20, but the scheme administrator may agree a higher RVF with HMRC if the particular benefit provision provided by the scheme warrants it.

A higher non-standard RVF will have a bearing on the level of the permitted margin (and hence the level of XP) - see comments on ‘calculation A’.

Example

In March 2007 Fred’s scheme pension is increased from £10,000 to £13,000 per annum through a one-off augmentation funded by his employer.

This increase is beyond the threshold annual rate.

The permitted margin to which Fred’s pension can be increased is £11,800. This means that Fred’s scheme pension has been increased by £1,200 over the permitted margin. XP is therefore £1,200.

So the amount that crystallises through BCE 3 for lifetime allowance purposes at that point is £24,000 (20 - the RVF that applies x £1,200).

Credit is given if at a later date further sums crystallise through BCE 3 (due to future increases to that scheme pension) in recognition of the fact that an earlier increase to that pension has already triggered a lifetime allowance test, and used up part of that individual’s lifetime allowance. So, as with other BCEs, no overlap occurs. How the credit is calculated depends on whether the further sums crystallising through BCE 3 occurred before 10 October 2007 or on, or after, that date. See ‘prevention of overlap’ below for more details.

Reduction of entitlement to cover lifetime allowance charge liability

Paragraph 13(4) Schedule 32 Finance Act 2004

Paragraph 43(5) Schedule 10 Finance Act 2005

If the member does not have sufficient available lifetime allowance to cover the amount crystallising through BCE 3 the scheme administrator may reduce the member’s pension entitlement in order to cover the lifetime allowance charge due on the chargeable amount arising at that BCE.

This potential reduction is ignored when calculating XP. So XP will be based on the full entitlement under the scheme before any reduction.

Where either the pension entitlement from the scheme is not reduced, or the reduction does not reasonably reflect the tax charge paid by the scheme administrator, based on normal actuarial practice, the tax charge paid by the scheme administrator is added on to the chargeable amount arising. It becomes what is called a scheme-funded tax payment. PTM085000 explains this in more detail.

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Prevention of overlap under BCE 3 when calculating ‘XP’ - further BCE 3 occurs on or after 10 October 2007

Paragraph 13(2) (2A), (2B) and (2D) Schedule 32 Finance Act 2004

Once an increase in a scheme pension in payment has triggered a lifetime allowance test through BCE 3 the level of excess pension (XP) that crystallised at that point will be excluded from the calculation of XP at any future event, where that same pension is potentially increased once again beyond the permitted margin at that time.

Where BCE 3 is triggered more than once, the notional XP at the latest point is discounted by the XP, or the total of the XP amounts, that crystallised at those earlier events.

The further BCE 3 event is discounted by increasing the XP, or the total of the XP, that crystallised at those earlier BCE 3 events by the greater of ‘calculation A’ and ‘calculation B’.

  • Calculation A involves increasing each XP that crystallised at an earlier BCE 3 event by the ‘relevant annual percentage rate’
  • Calculation B involves increasing each XP that crystallised at an earlier BCE 3 event by the ‘relevant indexation percentage’

An example is given below.

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Increasing XP by the relevant annual percentage rate

Once an increase in a scheme pension in payment has triggered a lifetime allowance test through BCE 3 the level of excess pension (XP) that crystallised at that point will be excluded from the calculation of XP at any future event, where that same pension is potentially increased once again beyond the permitted margin at that time.

Where BCE 3 is triggered more than once, the notional XP at the latest point is reduced by the XP, or the total of the XP amounts, that crystallised at those earlier events.

The XP at a further BCE event is reduced by increasing the XP that crystallised at the earlier BCE 3 event, or by increasing each XP (if there was more than one earlier BCE 3 event) by the greater of ‘calculation A’ and ‘calculation B’.

Under calculation A, the XP from the earlier BCE 3 is increased each year up to the point of the future BCE 3 by what is called the ‘relevant annual percentage rate’.

This will be 5 per cent per annum, unless the scheme has agreed with HMRC the use of a relevant valuation factor (RVF) that is greater than 20 for valuing all scheme pensions derived from that scheme for lifetime allowance purposes through BCE 2. Where such a non-standard RVF has been agreed HMRC will at the same time agree the relevant annual percentage rate that should be applied here for BCE 3 purposes.

The relevant annual percentage rate is applied on a compound basis for the whole intervening period between the point entitlement to the scheme pension initially arose to the point the increase concerned is being applied. There will be many instances where the intervening period will not be measured in whole years. In such cases, the relevant annual percentage is applied on a pro-rata basis by measure of months, counting the months the two points occur in as completed months. This is in contrast to the ‘relevant percentage rate’ that forms part of the threshold annual rate calculation. In that situation, a pro-rata basis is not required when considering a 5 per cent increase (or such greater amount if a non-standard RVF has been agreed) to a scheme pension that has been in payment for a period of less than 12 months at the time that the increase is awarded (see ‘the threshold annual rate - rounding up’ for more details).

A similar thing happens when calculating the relevant indexation percentage under calculation B. See the example below.

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Increasing XP by the relevant indexation percentage

Once an increase in a scheme pension in payment has triggered a lifetime allowance test through BCE 3 the level of excess pension (XP) that crystallised at that point will be excluded from the calculation of XP at any future event, where that same pension is potentially increased once again beyond the permitted margin at that time.

Where BCE 3 is triggered more than once, the notional XP at the latest point is reduced by the XP, or the total of the XP amounts, that crystallised at those earlier events.

Where the further BCE 3 occurs, the XP at that further event is reduced by increasing the XP that crystallised at the earlier BCE 3 event, or by increasing each XP (if there was more than one earlier BCE 3 event) by the greater of ‘calculation A’ and ‘calculation B’.

Under calculation B, the XP from the earlier BCE 3 is increased up to the point of the future BCE 3 by the rise in the RPI over the intervening period. This is the ‘relevant indexation percentage’.

As with calculation A, it is unlikely that the timescales involved will be periods of whole years. RPI figures are published on a monthly basis; the relevant table can be downloaded from the internet. (For instructions on how to find the RPI tables on the internet, see Retail Price Index (RPI) tables at the bottom of this page).

The relevant indexation percentage is the increase in the RPI for the period between the ‘base month’ and the ‘reference month’.

The reference month is any month chosen by the scheme administrator that is within the period of 12 months ending with the month in which the pensioner member became entitled to the scheme pension at the further increased rate, which is creating the latest BCE 3.

The base month is the month which is the same number of months before the month in which the pensioner member had the earlier BCE 3 in respect of the same scheme pension as the reference month is before the month in which the pensioner member became entitled to the scheme pension at the further increased rate, which is creating the latest BCE 3.

Allowing the scheme administrator to choose the reference month overcomes any uncertainty arising from the latest RPI figures not being available at the time calculation B is being undertaken in respect of a possible BCE 3. For example, if an increase is awarded in June 2008 the RPI figure for that June might not be available. If, instead, the chosen reference month is, say, April 2008 that would mean that the base month would have to be the month that is two months before the month in which the member had the earlier BCE 3.

The example below explains how this works.

The percentage should be rounded up to one decimal place (as this is consistent with how the RPI tables work).

The relevant indexation percentage can never be lower than 0 per cent.

Example

Raj is receiving a scheme pension and the rate of his pension is increased on 1 June 2006 from £10,000 to £13,000 per annum through a one-off augmentation funded by his employer.

For purpose of this example it is assumed that:

  • the threshold annual rate is exceeded, and
  • the permitted margin in respect of Raj’s pension is £11,800.

So, the excess over the permitted margin (XP) is £1,200 and the amount that crystallises through BCE 3 for lifetime allowance purposes is £24,000 (20 x £1,200).

On 1 February 2008 the rate of Raj’s pension is increased once again, this time to £30,000 per annum.

Again, for the purpose of this example, it is assumed that the threshold annual rate is exceeded and the permitted margin at the point of the latest increase comes to £20,000.

The XP from the previous BCE 3 (£1,200) now needs to be increased to determine how much of the potential XP in respect of the latest increase will be reduced by undertaking calculation A and calculation B. The potential XP at this point is the difference between the rate to which the pension has been increased and the permitted margin, which is £10,000 (£30,000 - £20,000).

Calculation A involves calculating what the level of the previous XP (£1,200) would be after applying the ‘relevant annual percentage rate’ to that XP for the intervening period between the previous BCE 3 and the latest increase to Raj’s pension. Counting the month in which the previous BCE 3 occurred and month of the latest increase as full months there are 21 months between the two points. The relevant annual percentage rate of 5 per cent per annum has to be applied on a pro-rata basis which gives the following result for calculation A.

5 per cent increase for the 12 months to 1 June 2007 takes the previous XP of £1,200 to £1,260.

Increase £1,260 pro-rata by the 5 per cent per annum to cover the 9 months from 1 June 2007 to 1 February 2008. The percentage increase here is 3.75per cent (9/12 x 5 per cent).

3.75 per cent of £1,260 is £48.

So the increased previous XP under calculation A is £1,308 (£1,200 + £60 + £48).

Calculation B involves calculating what the level of the previous XP (£1,200) would be after applying the ‘relevant indexation percentage’ to that XP for the intervening period between the previous BCE 3 and the latest increase to Raj’s pension.

As the RPI index value is not available for the month in which the latest increase is awarded (February 2008), the scheme administrator chooses December 2007 as the ‘reference month’ (the earliest month that the scheme administrator could have chosen is March 2007) to determine any increase in the RPI since the previous BCE 3. However, as the reference month (December 2007) is 2 months before the month in which Raj becomes entitled to his pension at the further increased rate (February 2008), the ‘base month’ must be April 2006 as this is the month that is 2 months before the month Raj had the previous BCE 3 in respect of an increase to his pension (June 2006).

The RPI index values for the month of April 2006 and December 2007 are 190 and 200 (note - these figures are estimated and are used for illustrative purposes only). The percentage rise in the RPI over the period is calculated as follows:

200/190 x 100 - 100 = 5.3 per cent. This is the relevant indexation percentage.

5.3 per cent of £1,200 = £64

So the increased previous XP under calculation B is £1,264 (£1,200 + £64)

As the resulting figure from calculation A is higher than calculation B, the amount to which the previous XP can be increased is £1,308 - the figure found under calculation A.

The amount found under calculation A is deducted from the potential XP to determine whether or not there is any actual XP in respect of the latest increase given to Raj’s pension. For this latest increase there will be an XP as the potential XP less the increased XP from the previous BCE 3 leaves an amount of £8,692 (£10,000 - £1,308).

So, the excess over the permitted margin (XP) in respect of the further increase given to Raj’s scheme pension on 1 February 2008 is £8,692 and the amount that crystallises through BCE 3 for lifetime allowance purposes is £173,840 (20 x £8,692).

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Ill-health scheme pension ceases or reduces (BCEs 2 and 3)

A scheme pension paid before the normal minimum pension age on grounds of ill-health is tested for lifetime allowance purposes through BCE 2 at the point entitlement arises. At a later date payment of that scheme pension may be stopped by the scheme because the member’s health improves.

When the scheme re-commences paying that scheme pension to the member concerned, for example, because normal minimum pension age has been reached, the re-commenced pension is viewed as still representing payment of the original scheme pension. It is not tested again for lifetime allowance purposes through BCE 2. Where such a pension re-commences any increase in that pension level since the point it was stopped is within the scope of BCE 3. If the rate of scheme pension payable has increased over the intervening period at a greater rate than the permitted margin, that excess (XP) would crystallise at that point under BCE 3.

For more details and an example, see BCE 2 at PTM088620.

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Retail Price Index (RPI) tables

For certain pension benefit-related calculations, registered pension schemes will need to refer to the Retail Price Index tables. To find these tables:

  • begin at the Office for National Statistics home page: http://www.ons.gov.uk/ons/index.html (Website)
  • click on Consumer Prices Index (under Key Figures on the right hand side of the homepage) - this will always take you to the most recently published information
  • scroll down to the sub-heading ‘In This Release’ and open the spreadsheet called Consumer Price Inflation Reference Tables (found in the third paragraph under the 6 links)
  • the contents page provides a comprehensive list of tables with hyperlinks that are included - you will need to refer to Table 36 for the RPI indices.