Good News On Pension Lump Sums
Amongst much of the doom and gloom presaged in the Chancellor’s last Budget Statement, the Finance Bill 2008 published at the end of March contained some welcome good news on Pension Commencement Lump Sums (PCLS), more commonly known as tax-free cash.
The transitional protection rules for PCLSs above 25% are to be changed. This will allow larger tax-free lump sums for some people, with nobody being worse off than before.
Protected tax-free lump sums above 25%
When Pension Simplification was introduced, the new framework contained transitional protection rules allowing members of occupational pension schemes to protect any rights to tax-free lump sums of more than 25% built up before 5 April 2006 under the old regime. The rules were, however, different depending on whether or not the member continued to build up benefits under the protected pension scheme after 5 April 2006. This difference caused practical administrative difficulties, particularly for defined benefit schemes.
The Finance Bill makes a positive change that will remove this distinction and introduce a level playing field, simplifying the position and removing anomalies.
The lump sum allowed will now always be calculated as:
(a) 5th April 2006 lump sum amount increased in line with Lifetime Allowance;
plus
(b) 25% x (Fund value – (5th April 2006 fund value increased in line with Lifetime Allowance))
Before the change, members who did not make contributions post 5th April 2006 would only have been allowed the revalued 5th April 2006 lump sum as in (a) of the above formula. Many will now be entitled to much higher lump sums.
Let’s look at an example to help illustrate the point.
Suppose Stephen has an old paid-up executive pension worth £100,000 at 5th April 2006, with a tax-free lump sum entitlement of £50,000. Stephen hasn’t worked for that company since 2001, so he cannot make any more payments to the plan.
Stephen takes his benefits in tax year 2010/11, when his plan is worth £200,000 and the lifetime allowance has increased from £1.5m to £1.8m.
Under the original rules, Stephen’s maximum lump sum would have been £60,000, i.e. £50,000 x 1.8/1.5.
Under the new rules, Stephen’s maximum lump sum will be £80,000, i.e. £60,000 as before plus 25% x (£200,000 – (£100,000 x 1.8/ 1.5)).
This change will be backdated to 6th April 2006 and Her Majesty’s Revenue & Customs (HMRC) has announced that schemes can take advantage of it immediately.
Date of Article: 6th May 2008
