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Adviser  >  Technical Central  >  Support material  >  Case Studies  >  Large Pension Fund

Large Pension Fund

In this case study we will compare 2 different scenarios for Ben, an existing member of an executive pension plan (EPP), who had benefits valued at over £1.5 million on 5 April 2006 (day before A-Day). In one scenario he does not seek financial advice until it’s too late and in the other he gets advice.

Scenario 1 – no financial adviser until it's too late

Ben is the managing director of a successful IT company and has worked there since 1960. In 1970 he took financial advice and set up an EPP. Contributions of £30,000 p.a. are currently paid into Ben’s EPP and he earns £500,000 p.a. He does not anticipate that these figures will change between now and retirement. When he set up his EPP his financial adviser told him that as long as he remained in the EPP until he was due to retire, he could have a tax-free lump sum (this is now known as a 'pension commencement lump sum', or PCLS for short) of 1.5 times his average earnings at retirement.

Ben did not have a financial adviser for several years as he made no changes to his plan and did not think that a financial adviser was necessary. But, in January 2010, he decides to take (crystallise) his pension and finds himself a new financial adviser who starts to look at his EPP and discovers the following:

Benefits value on 5 April 2006 = £1.8 million Earnings on 5 April 2006 = £500,000 Number of years pensionable service up to 5 April 2006 = 36 Pre A-Day entitlement to PCLS = £750,000 (based on pre-87 uplifted scale) Benefits value at crystallisation date = £2.1 million (total benefits value split £2 million pre A-Day and £100,000 post A-Day) Earnings at crystallisation date = £500,000 PCLS Entitlement to a PCLS on pre A-Day benefits value = £750,000 x £1.75 million = £875,000                  £1.5 million Entitlement to a PCLS on post A-Day benefits value = [£2.1 million - (£1.8 million x £1.75 million)] divided by 4 = £0                                           £1.5 million Total entitlement to PCLS = £875,000

Ben’s financial adviser has to explain the retrospective changes that took place on A-Day. As Ben had not applied for primary or enhanced protection at A-Day (as he didn’t know that he needed to) he was advised that as his benefits value is more than the statutory lifetime allowance (SLA) at his pension benefits crystallisation date (the SLA for 2009/2010 is £1.75 million) a lifetime allowance charge of 55% will have to be paid on the his excess benefits value over £1.75 million, if he chooses to take this as a lump sum.

If Ben decides to take his excess benefits value in the form of a lump sum then he will be able to take the following benefits:

PCLS	Pre A-Day PCLS increased in line with the SLA plus post A-Day PCLS of 25% of the post A-Day funds	See previous calculations	£875,000
Taxed lump sum	Amount in excess of SLA taxed at 55%	(£2.1 million - £1.75 million) less 55%	£157,500
Amount available to purchase an annuity	SLA less PCLS	£1.75 million less £875,000	£875,000

Ben had a benefits value of £2.1 million. The net value of the benefits that he is taking is £1.9075 million.

£192,500 has been paid to HM Revenue & Customs by way of a lifetime allowance charge.

Although Ben is able to have a PCLS which is more than the 1.5 times earnings he thought that he could have, he is having to pay the tax man £192,500 which is not something that he thought that he would have to do!

But what if Ben had spoken to a financial adviser…

Scenario 2 – has always had a financial adviser

Before A-Day Ben’s financial adviser contacted him to discuss the implications of the 6 April 2006 legislation. During the discussions Ben advised that, if possible, he wanted to avoid the lifetime allowance charge.

His adviser suggested that Ben should apply for primary protection. This would mean that his entitlement to a PCLS would be protected and there was less chance that he would have to pay a lifetime allowance charge.

Between A-Day (6 April 2006) and January 2010 when Ben crystallises his pension benefits he continues to pay contributions to his EPP. His financial adviser contacts him in 2010 to advise him that the following benefits can be taken:

Benefits value on 5 April 2006 = £1.8 million Statutory lifetime allowance on A-Day = £1.5 million Personal lifetime allowance (PLA) at A-Day = £1.8 million = 120% SLA                                                                   £1.5 million Benefits value at crystallisation date = £2.1 million SLA in tax year 2009/2010 = £1.75 million PLA at crystallisation date = £1.75 million x 120% = £2.1 million As Ben’s PLA at his crystallisation date is the same as his benefits value of his EPP, Ben does not have to pay a lifetime allowance charge PCLS PCLS at 5 April 2006 = £750,000 Entitlement to PCLS = £750,000 x £1.75 million = £875,000                                                    £1.5 million

In the second scenario Ben’s benefits value was well over the statutory lifetime allowance at his crystallisation date, but as he had opted for primary protection, and his benefits value was the same as his personal lifetime allowance, he does not have to pay a lifetime allowance charge of £192,500. The benefits payable represents his full EPP benefits value. However, under primary protection no more PCLS rights build up from post A-Day growth.

If Ben does take advice he could still decide that he does not want to opt for protection. This would mean that he could take a larger lump sum at crystallisation date. He would, however, have to pay the lifetime allowance charge. By speaking to his financial adviser he knows what his options are and he can make an informed decision.

This case study is an example only, and while it highlights some of the opportunities for planning, it should be recognised that it is not a complete or exhaustive description of the opportunities or pitfalls.

This information is based on our current understanding of the Finance Act 2004 and Finance Act 2005.

Published 10 January 2005

Updated 10 June 2008