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Pensions Tax Manual

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Protection from the lifetime allowance charge: lifetime allowance enhancement factors: The non-residence factor for defined benefits arrangements

Glossary PTM000001
   

 

How to calculate the non-residence factor for a defined benefits arrangement
Example of how to calculate the non-residence factor for a defined benefits arrangement
How to calculate the non-residence factor for a defined benefits arrangement if primary protection has also been claimed
Example of how to calculate the non-residence factor if primary protection has also been claimed

How to calculate the non-residence factor for a defined benefits arrangement

Sections 223(3) and (4) and 277 Finance Act 2004

For each part of an active membership period (see PTM095310) during which the individual is a relevant overseas individual (see PTM095310), the defined benefits arrangement non-residence factor is established as follows:

  1. multiply the individual’s pension entitlement under the defined benefits arrangement as at the latest of the following dates by the relevant valuation factor of 20 or a factor greater than 20 as agreed by HMRC:
* the date when the individual became a relevant overseas individual
* the date when benefits first began to accrue to or in respect of the individual under the defined benefits arrangement, and
* 6 April 2006.

Where the registered pension scheme rules provide for a separate lump sum that is not a commutation of pension it is necessary to take that into account as well. That is done by adding to the amount resulting from the above calculation the separate lump sum entitlement that the individual has under the defined benefits arrangement as at the latest date above. This only applies if the lump sum entitlement is not linked to the individual’s pension entitlement so that their prospective pension entitlement is not reduced as a result of taking the lump sum.

  1. multiply the individual’s pension entitlement under the defined benefits arrangement as at the earliest of the following dates by the relevant valuation factor of 20 (or a factor greater than 20 as agreed by HMRC):
* immediately before the benefit crystallisation event,
* the date when the individual ceased to be a relevant overseas individual, and
* the date when benefits ceased to accrue to or in respect of the individual under the defined benefits arrangement.

Where the registered pension scheme rules provide for a separate lump sum that is not a commutation of pension it is necessary to take that into account as well. That is done by adding to the amount resulting from the above calculation the separate lump sum entitlement that the individual has under the defined benefits arrangement as at the earliest date above. This only applies if the lump sum entitlement is not linked to the individual’s pension entitlement so that their prospective pension entitlement is not reduced as a result of taking the lump sum.

  1. deduct the result of 1 from the result of 2.
  2. express the resulting amount as a factor of the standard lifetime allowance as at the date in 2.

If there was an earlier part of the active membership period relating to the arrangement during which the individual was a relevant overseas individual the two factors for the two part-periods should be aggregated.

The individual’s pension entitlement under the defined benefits arrangement is the annual rate of pension which would be payable to or in respect of the individual if they became entitled to payment of it at the applicable date (as determined under 1 or 2 above). The individual’s lump sum entitlement under the defined benefits arrangement is the amount of lump sum which would be payable to or in respect of the individual if they became entitled to payment of it at the applicable date.

Both the pension entitlement and the lump sum entitlement are established using the valuation assumptions set out in section 277 Finance Act 2004. These are as follows:

  • the individual concerned has reached any designated age as must have been reached to avoid any reduction in their benefits on account of their age, and
  • their benefits should be valued on the basis that they are not physically or mentally impaired.

Exceptionally, the calculation of the opening value at 1 above is modified where the individual has also notified HMRC that they are claiming primary protection under paragraph 7(1)(b) of schedule 36 (see PTM092300). That is to prevent the individual qualifying for two lifetime allowance enhancement factors in respect of the same increase in benefits. Guidance on how that calculation is modified is provided below.

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Example of how to calculate the non-residence factor for a defined benefits arrangement

Vicky began working overseas on 6 December 2006 and so she became a relevant overseas individual on 6 April 2007. She began to accrue benefits under her defined benefits arrangement on 6 November 2006. The latest date for the purposes of step 1 at How to calculate the non-residence factor for a defined benefits arrangement above is therefore 6 April 2007.

Vicky’s pension entitlement as at 6 April 2007 was £40,000 p.a. She had an option under the rules of the registered pension scheme defined benefits arrangement to commute part of her pension entitlement for a lump sum on retirement. She was not entitled to a separate lump sum.

£40,000 x 20 = £800,000

Vicky returned to work in the UK on 6 June 2009 and so she ceased to be a relevant overseas individual on 5 April 2009. That was before a benefit crystallisation event and before she ceased to accrue benefits under the defined benefits arrangement. Her pension entitlement as at 5 April 2009 was £56,500 p.a.

£56,500 x 20 = £1.13 million

£1.13 million - £800,000 = £330,000

The defined benefits arrangement non-residence factor is therefore 0.2. That is calculated by dividing £330,000 by £1.65 million (the standard lifetime allowance for the 2008-2009 tax year).

£330,000/£1.65 million = 0.2

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How to calculate the non-residence factor for a defined benefits arrangement if primary protection has also been claimed

Articles 12 and 14 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 -SI 2006/572

Where the individual is also claiming primary protection the calculation of the opening value at 1 at How to calculate the non-residence factor for a defined benefits arrangement above is modified if the individual would have been a relevant overseas individual in the 2005-06 tax year had the definition of a relevant overseas individual (see above -section 221(3) Finance Act 2004) been in force then, and if the conditions in either a or b below are met:

  1. The individual has notified HMRC of their entitlement to a non-residence factor where the active membership period in relation to the defined benefits arrangement began on 6 April 2006, and notifies - or has already notified - HMRC of their intention to rely on primary protection.
  2. The individual has notified HMRC of their intention to rely on primary protection, and notifies - or has already notified - HMRC of their entitlement to a non-residence factor where the active membership period in relation to the defined benefits began on 6 April 2006.

The opening value at 1 at How to calculate the non-residence factor for a defined benefits arrangement above is calculated instead by taking the individual’s pension entitlement and separate lump sum entitlement (if any) under the arrangement as at 5 April 2006, increased by dividing the standard lifetime allowance at the earliest of the three dates specified at 2 at How to calculate the non-residence factor for a defined benefits arrangement above by £1.5 million

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Example of how to calculate the non-residence factor if primary protection has also been claimed

Sally, who is working in Spain and would have been a relevant overseas individual in 2005/06 had the definition existed and applied at that time. She has claimed primary protection. Her pension entitlement in her defined benefits arrangement as at 5 April 2006 was £40,000 pa. She was also entitled to a separate lump sum of £200,000.

She returned to work in the UK on 6 December 2011 (before a benefit crystallisation event and before she ceased to accrue benefits under the cash balance arrangement). She therefore ceased to be a relevant overseas individual on 5 April 2011. Her pension entitlement in the arrangement as at 5 April 2011 was £65,000 pa. She was also entitled to a separate lump sum of £260,000.

The value at 1 at How to calculate the non-residence factor for a defined benefits arrangement above is £1.2 million. That is worked out by:

  • multiplying £40,000 by 20 to arrive at £800,000,
  • adding £200,000 to arrive at £1 million, and
  • multiplying £1 million by 1.2, which is the product of dividing £1.8 million (the standard lifetime allowance for the 2010-2011 tax year) by £1.5 million.

The value at 2 at How to calculate the non-residence factor for a defined benefits arrangement above is £1.56 million. That is worked out by multiplying £65,000 by 20 and adding £260,000.

The difference between that opening value and the closing value of Sally’s rights in the arrangement is £360,000 i.e. £1.56 million minus £1.2 million.

The defined benefits arrangement non-residence factor is therefore 0.2. That is calculated by dividing £360,000 by £1.8 million (the standard lifetime allowance for the 2010-2011 tax year).