Pension commencement lump sum permitted maximum guide

Transcription

1 ADVISER FACTSHEET Tech Talk November 2017 Pension commencement lump sum permitted maximum guide Contents Introduction PCLS conditions PCLS tax treatment Permitted maximum categories Comment For professional advisers only

2 Introduction The benefits section of pension marketing material will invariably make reference to the individual s option to take a portion of their retirement fund as a lump sum usually tax free. Some individuals make use of this lump sum as part of a tax efficient income withdrawal strategy. While others see it as providing the wherewithal to clear debt, make a once in a lifetime purchase, financially support younger generations or as way of raising capital for a business venture. Whatever its use the lump sum, as evidenced by the furore whenever mention is made of its demise, is one of the more attractive features of saving for retirement through a registered pension scheme. As a result an important question for advisers and their clients is how much tax free lump sum can be obtained from a pension arrangement? Legislation sets out the conditions for accessing PCLS and also places restrictions on the amount available. In order to answer the how much tax free lump sum can be obtained from a pension arrangement question it is necessary to delve into pension tax legislation. Unfortunately as individuals circumstances vary, so too does the restriction on the amount of PCLS available to them. In the legislation this restriction is referred to as the permitted maximum and what follows is a guide to establishing the permitted maximum given a particular set of circumstances. Note that the permitted maximum may not be available under a particular scheme because of restrictions contained within that specific scheme s rules. There are a number of different authorised lump sums that may be paid from a registered pension scheme in different circumstances, some tax free, some not. The lump sum covered in this Tech Talk is the pension commencement lump sum (PCLS) paid at the time retirement benefits are taken by members. 2

3 PCLS conditions There are various conditions that a lump sum paid by a scheme to a member must meet in order for it to be a PCLS and these are outlined in PTM The bullet points that follow summarise the content of PTM Please bear in mind that there are circumstances where even though a lump sum does not meet all the conditions outlined below it may still be treated as a PCLS. In the interests of brevity and to avoid further complication these circumstances are not covered in this bulletin. The PCLS must be connected to an arising entitlement to a relevant pension benefit under the same registered pension scheme. The definition of relevant pension includes income withdrawal, a lifetime annuity or a scheme pension. There is an exception to this condition where the member enjoys scheme specific lump sum protection (see relevant section on page 8) in that in certain circumstances it can be paid in connection with a trivial lump sum (not to be confused with a trivial commutation lump sum) rather than a pension from the scheme under which the member has the protection. It is possible for a PCLS to be paid in anticipation of being entitled to a relevant pension but the member dies before that entitlement arises. Where certain conditions are met it is possible for all of a member s uncrystallised rights in a registered pension scheme to be paid as a lump sum. This is known as a stand-alone lump sum. A stand alone lump sum is a lump sum is its own right and will not be covered in this Tech Talk. The member must have some of their lifetime allowance available at the time of payment unless they enjoy the form of lump sum protection associated with enhanced protection (see relevant section on page 6). Solely for the purposes of deciding whether the member satisfies this condition the fact that a BCE 5 or BCE 5B (both BCEs occur where a member has unvested rights at age 75) has occurred is disregarded. This means that any lifetime allowance used up by that BCE does not count when calculating whether the member has available lifetime allowance. Also, if the member has already taken benefits from a registered pension scheme after reaching age 75 or some other event has occurred that would have been a BCE but for the fact that the event occurred on or after the member reaching age 75, then, again solely for the purposes of calculating whether the member has available lifetime allowance, those events are treated as though they were BCEs and so are treated as having used up lifetime allowance. The lump sum must be paid within an 18-month period starting 6 months before and ending 12 months after the member becomes entitled to it. Entitlement to the PCLS arises on the day that actual entitlement (as opposed to prospective entitlement) to the linked relevant pension arises. The lump sum must not be paid until the member has reached normal minimum pension age unless the member has a protected pension age under the scheme or becomes entitled to a relevant pension on the grounds of ill health. The lump sum payment must not be what the legislation defines as an excluded lump sum. The amount which can be treated as a PCLS is an amount which does not exceed the permitted maximum. This Tech Talk focuses solely on the final condition in the above list. 3

4 PCLS tax treatment Subject to scheme rules and the minimum age condition mentioned above a member can take a PCLS at any time before and after age 75. Irrespective of what age it is taken at the lump sum is free from income tax. However, where it is taken before age 75 it triggers a benefit crystallisation event (BCE 6) and a lifetime allowance test. The BCE 6 generated is deemed to occur before the benefit crystallisation event associated with the linked relevant pension. Because of this and the way the permitted maximum is defined there are only two scenarios where there is the possibility of the lump sum being subject to a lifetime allowance charge. The scenarios are where the member has the form of lump sum protection associated with primary protection or where the member has scheme specific lump sum protection. These forms of lump sum protection are discussed below. Therefore in the vast majority of cases a PCLS will be tax free and because of this many people still refer to it as tax free cash. 4

5 Permitted maximum categories As mentioned above one of the conditions a lump sum must meet for it to be a PCLS is that it does not exceed the permitted maximum. The definition of the permitted maximum depends on the member s circumstances, in particular which one of the four categories they fall into at the time of payment. Each category is now looked at in turn. No lump sum protection Under this category none of the 3 forms of lump sum protection apply to the member at the time benefits are taken from the scheme. However, the member may benefit from a form of lifetime allowance protection e.g. primary or fixed protection and this has implications for the permitted maximum under this category. The permitted maximum applicable for this category is the lower of 25% of the value of the benefits (PCLS and relevant pension) coming into payment under the scheme from which the lump sum is being paid and the cap (see below for the definition of the cap). Any benefits attributable to a disqualifying pension credit and, where a money purchase arrangement is involved, any lifetime annuity or scheme pension purchased from drawdown funds are excluded from the value of benefits. The value placed on the benefits coming into payment is the lifetime allowance crystallised amount with the exception of a scheme pension provided from a money purchase arrangement where the value is the scheme pension purchase price. A pension credit is a disqualifying pension credit if at the time the pension credit was created, the member s ex-spouse or former civil partner s pension that was being shared was actually in payment. In legislation the cap referred to above is known as the available portion of the member s lump sum allowance and is defined by the following formula: (CSLA AAC)/4 CSLA is the current standard lifetime allowance AAC is the aggregate of the relevant amount in the case of all earlier BCEs which have occurred in relation to the member each adjusted by a specified indexation factor. The relevant amount in the case of a BCE is the amount crystallised by it with the exception of a scheme pension secured from a money purchase arrangement where the scheme pension purchase price is used. The indexation factor referred to in the definition ACC is as follows: CSLA/PSLA CSLA is as defined above. PSLA is the standard lifetime allowance at the time of the previous BCE. Note that where the member holds one of the forms of fixed or individual protection at a BCE, then the definitions of CSLA and PSLA are amended to reflect the lifetime allowance applicable to the member at the BCE. If however, the member holds either enhanced or primary protection the definitions of CSLA and PSLA are as follows: CSLA is 1.5m where this is greater than current standard lifetime allowance. PSLA is 1.5m where greater than the standard lifetime allowance at the previous BCE and where the current and previous BCEs both occurred on or after 6 April 2014, otherwise it is the standard lifetime allowance at the previous BCE. When calculating the cap for a member aged 75 or older certain adjustments are required. The amounts crystallised under BCE 5 or BCE 5B are ignored and if the member has already taken benefits after reaching age 75 or some other event has occurred that would have been a BCE but for the fact that the event occurred on or after the member reaching age 75, a BCE is deemed to have occurred. Therefore, where the member has no lifetime allowance protection or holds one of the forms of fixed or individual protection the cap formula can be simplified by using the percentage of the lifetime allowance used up from any previous BCE. Note that the lifetime allowance used up by a scheme pension from a money purchase arrangement would be calculated based on the scheme pension purchase price and not on the actual amount crystallised. 5

6 EXAMPLE 1 Kelly, aged 70, is about to fully crystallise her SIPP currently valued at 400,000. She had no lifetime allowance protection until recently when she made a successful application for fixed protection Her only previous BCE was in 2007/08 (SLA = 1.6m) where the total amount crystallised was 1.12m. She has no lump sum protection. What is the maximum PCLS available from her SIPP? Kelly has used up 70% of her lifetime allowance: BCE 2007/08: 1.12m/ 1.6m = 70% Therefore has 30% remaining: PCLS permitted maximum cap = 25% of (30% of 1.25m) = 93,750 Maximum PCLS available is 93,750 and not 100,000 Using cap formula: [ 1.25m ( 1.12m x 1.25m/ 1.6m)]/4 = 93,750 EXAMPLE 2 Hector, aged 70, is about to fully crystallise his SIPP currently valued at 400,000. He has enhanced protection and no lump sum protection. His only previous BCEs were in 2007/08 (SLA = 1.6m) where the total amount crystallised was 1.12m and in 2014/15 (SLA = 1.25m) where total amount crystallised was 125,000. What is the maximum PCLS available from his SIPP? Relevant amount Adjustment factor ACC BCE 2007/08 1,120, /1.6 1,050,000 BCE 2014/15 125, / ,000 1,175,000 PCLS permitted maximum cap = (CSLA AAC) / 4 = ( 1.5m 1.175m)/4 = 81,250 Maximum PCLS available is 81,250 and not 100,000 Under this category the member has no form of lump sum protection. However, depending on the circumstances a member may benefit from one of 3 forms of lump sum protection. What follows is a brief description of each of the forms of protection in terms of the qualifying conditions and the respective PCLS permitted maximums. Enhanced protection and lump sum rights as at 5 April 2006 exceeded 375,000 In order for this form of lump sum protection to apply both conditions must be met at the time the lump sum payment is being made. Therefore, if the member as the result of a previous occurrence is no longer entitled to enhanced protection then they cannot rely on this form of lump sum protection. Likewise, if the member currently holds enhanced protection but their lump sum rights as at 5 April 2006 did not exceed 375,000, then they cannot rely on this form of lump sum protection. In determining whether the lump sum condition was met note that both uncrystallised and crystallised rights as at 5 April 2006 would have been taken into account. The lump sum attributable to crystallised rights as at 5 April 2006 is defined by legislation. 6

7 A member who has enhanced protection will have received a certificate from HMRC confirming this. Where the member is also entitled to this form of lump sum protection the certificate shows the percentage of the value of total benefits coming into payment that can be paid as a PCLS. The percentage shown is the PCLS permitted maximum and represents the following ratio: VULSR/VUR VULSR is the value of the uncrystallised lump sum rights at 5 April 2006 VUR is the value of the uncrystallised pension rights at 5 April 2006 Given that the deadline for applying for enhanced protection has long since past, whether a member benefits from this form of lump sum protection is evidenced by the existence of a valid certificate containing the appropriate information. Whilst a member holds this form of lump sum protection they do not need to have available lifetime allowance to be paid a PCLS. EXAMPLE 3 Asha, aged 70, is about to fully crystallise her SIPP currently valued at 1.2m. She has enhanced protection and her certificate shows she has a PCLS permitted maximum of 27%. In 2009/10 (SLA = 1.75m) she took a PCLS of 400,000 and an initial scheme pension of 70,000 pa from a defined benefit arrangement. What is the maximum PCLS available from her SIPP? BCE in 2009/10: total amount crystallised was 1.8m 400,000 + (20 x 70,000), note PCLS < 27% Current BCE: Maximum PCLS available from the SIPP is 27% of 1.2m = 324,000, note that it is not possible to use unused portion of the percentage from the previous BCE. Primary protection and lump sum rights as at 5 April 2006 exceeded 375,000 Similar to the previous category both the lifetime allowance protection and the lump sum condition must be met if the member is to benefit from this form of lump sum protection. In determining whether the lump sum condition was met both the uncrystallised and crystallised rights as at 5 April 2006 would have been taken into account. A member who enjoys primary protection will have received a certificate from HMRC confirming this. Where the member is also entitled to this form of lump sum protection the certificate shows a monetary amount representing the value of the member s uncrystallised lump sum rights at 5 April The PCLS permitted maximum is defined by the following formula: VULSR APCLS, where: VULSR = value of uncrystallised lump sum 5/4/2006 x ULA/ 1.5m APCLS = PCLS or stand alone lump sum paid previously x ULA/PSLA ULA = 1.8m or current SLA if greater PSLA = previous payment (prior to 6 April 2012) PSLA = 1.8m if greater than previous payment (post 5 April 2012) Whether a member benefits from this form of lump sum protection is evidenced by the existence of a valid certificate containing the appropriate information. With this form of lump sum protection the available lifetime allowance condition still applies and if the member s available lifetime allowance is not enough to cover all of the PCLS payment part of it will be subject to a lifetime allowance charge. 7

8 EXAMPLE 4 Sven, aged 70, is about to fully crystallise his SIPP currently valued at 400,000. He has primary protection and his certificate shows that the value of his uncrystallised lump sum rights at 5/4/2006 were 0.5m. His only previous BCEs were in 2007/08 (SLA = 1.6m) and in 2014/15 (SLA = 1.25m). Given the information below what is the maximum PCLS available from his SIPP? PCLS taken Adjustment factor APCLS BCE 2007/08 200, / ,000 BCE 2014/15 100, / , ,000 PCLS permitted maximum = VULSR APCLS = ( 0.5m x 1.8m/ 1.5m) 325,000 = 275,000 Scheme specific lump sum protection As the title suggests where a member holds this type of lump sum protection it only applies to their lump sum entitlement under a specific registered pension scheme. Note that the other two forms of lump sum protection outlined above take precedence over this form of lump sum protection. For a member to have this form of protection then as at 5 April 2006 the following ratio must exceed 25% VULSR/VUR VULSR and VUR are as defined on the previous page with the exception that the ratio only takes into account rights under the scheme (or original scheme where there has been a block transfer). Therefore, for a member to have this form of lump sum protection they must have been a member of a scheme or had rights under a deferred annuity contract that were subject to occupational pension scheme benefit limits prior to 6 April It follows that this form of protection cannot apply to personal pension schemes unless there has been a block transfer in relation to the member into the personal pension scheme on or after 6 April There is no need to claim this protection from HMRC. The legislation applies the protection to the member automatically. However, the scheme administrator must be satisfied that the member is entitled to it. Except in certain circumstances (see PTM063130) the member must become entitled to their entire pension rights (that were not in payment on 5 April 2006) under the scheme on the same day for this protection to apply. Therefore, if the member is to retain this form of protection it rules out the option of phasing benefits under the scheme. As mentioned above there is a condition that a PCLS must be paid in connection with an entitlement to a relevant pension. However, a scheme specific protected lump sum may instead be paid in connection with a trivial lump sum (see PTM for a definition). Note that this is a special kind of trivial lump sum and it should not be confused with the usual trivial commutation lump sum. With this form of lump sum protection the available lifetime allowance condition still applies and if the member s available lifetime allowance is not enough to cover all of the PCLS payment part of it will be subject to a lifetime allowance charge. For individuals who are members of more than one registered pension scheme and have this protection under a particular scheme, the PCLS permitted maximum category for the other schemes will be either no lump sum protection or scheme specific lump sum protection. 8

9 The PCLS permitted maximum under the scheme is defined by the following formula: VULSR x ULA/ 1.5m plus ALSA ULA is as defined above ALSA = [LS + AC (VUR x CSLA/ 1.5m)] /4, nil where < 0 LS = amount of PCLS actually paid Where there has been a partial transfer out in respect of the member, the PCLS permitted maximum is adjusted to reflect the transfer out. From the formula above the following amount is subtracted: TV/4 TV = the value of the sums and assets transferred out of the scheme after 5 April 2006 AC = amount crystallised by pension paid with PCLS CSLA is the current SLA or personalised lifetime allowance if greater than current SLA where member holds a form of fixed/individual protection or 1.5m if greater than current SLA where member holds either enhanced or primary protection. EXAMPLE 5 Sheila, aged 60, is about to fully crystallise her money purchase occupational pension scheme currently valued at 210,000. Her intention is to take the maximum PCLS and use the remainder to purchase a lifetime annuity to take advantage of the guaranteed annuity rate under the scheme. The table below shows the value of the rights she held under the scheme as at 5/4/2006. There have been no partial transfers out of scheme in respect of Sheila. Scheme rights Value VULSR 60,000 VUR 180,000 She has enough lifetime allowance to cover both BCEs (PCLS and lifetime annuity). Consider: Option 1 Sheila has no lifetime allowance protection Option 2 Sheila has fixed protection 2014 The scheme will pay the PCLS permitted maximum. How much can be paid under both options? Option VULSR x 1.8/1.5 A LS + AC VUR CSLA/1.5 ALSA B 1 60,000 x 1.8/ , ,000 1/1.5 ( 210, ,000)/4 2 60,000 x 1.8/ , , /1.5 ( 210, ,000)/4 Option A B PCLS permitted maximum A + B Lifetime annuity purchase price AC 1 72,000 22,500 94, , ,000 7,500 79, ,500 9

10 Comment The primary aim of this Tech talk is to give advisers an insight into how pension tax legislation restricts the amount of PCLS available to members of registered pension schemes. In cases where individuals have no lifetime allowance issues and have no limitations imposed by scheme rules, the restriction or permitted maximum will usually equate to 25% of the value of the benefits coming into payment. This is simple enough, making it easy for advisers and their clients to understand. Unfortunately, where clients circumstances dictate that the simple 25% limit does not apply quantifying the permitted maximum becomes more difficult. Being able to quantify this accurately is crucial if advisers are to assist their clients in meeting their retirement planning needs. It is hoped that advisers find the content of this bulletin useful in making sense of the complexity that surrounds this topic, enabling them to confidently forecast the amount of tax free cash their clients will receive. Further information John Dunn Pension Specialist Technical Support Unit Visit the Technical Hub for further information: Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL, IPS Plc, PAL, STL, UPT and UPTL have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(06/17) JHSTT 01 NOV17 LD 10