Commutation of pension for increased lump sum

kostigovs

My wife is planning to retire in August of this year. She is self employed contracted to the NHS and she has been advised what her pension and lump sum is as of 5/4/11.

If she so wishes she can increase her lump sum by commuting part of her pension albeit the additional lump sum amount cannot exceed 25% of the fund value.

Is there an easy way to calculate fund value or does she just have to ask the pension provider.

jem16

kostigovs wrote: »

Is there an easy way to calculate fund value or does she just have to ask the pension provider.

Easiest way is to use the calculator on their website.

http://www.nhspa.gov.uk/PDweb/PensionCalculators/PensionCommutation/index.htm

kostigovs

Thanks. I've come across a similar website and it has produced similar figures.
What i was actually trying to find out was the size of the fund not the maximum she could get in the way of an enhanced lump sum

Zelazny

kostigovs wrote: »

Thanks. I've come across a similar website and it has produced similar figures.
What i was actually trying to find out was the size of the fund not the maximum she could get in the way of an enhanced lump sum

From what you say, it sounds like she has a DB pension (final salary) and in that case there is no "fund" - there's just an obligation for the pension scheme to provide a pension of x amount, where x is determined based on her length of service, final salary and accrual rate.

Different schemes use different commutation factors, and this can cause some confusion over the maximum lump sum available. The government's criteria for working out the 25% figure is based on pension being worth 20:1 against cash, but most schemes offer lower commutation factors than this. 12:1 is not uncommon. In that case, you need to know the maximum pension and the commutation factor, and can then use the following formula:

(CF x FP) / (1 + [0.15 x CF])

Where CF is the commutation factor, FP is the full pension.

This becomes rather more complicated if there are money purchase benefits in addition, or if different parts of the benefit have different commutation factors, but it gives an idea.

For example, if your full pension is £10,000 p.a. and the commutation factor is 12:1, then the calculation is:

(12 x 10000) / (1 + [0.15 x 12])
= 120000 / 2.8
= £42,857.14

This would leave you with a residual pension of:
10000 - (42857.14/12) = £6,428.57 p.a.

Looking at the figures, you'd think that you've commuted more than 25% (as the pension has dropped by over 35%) but the government calculation is as follows:

"value" of residual pension: 6428.57 x 20 = 128571.4
"value" of cash: 42857.14.
Total: 171428.54
25% limit: 42857.14

kostigovs

I'm obviously not explaining myself very well so I will break it down to actual figures.
My wife's pension will be £25k and her lump sum £75K.
Using the SPPA formula for calculating her increased lump sum i.e. 20 x pension=£500000 plus 20/12 x lump sum= £125000 giving a total of £625000 divided by 4.6667=£133927 the maximum lump sum she could get is £133927, which represents an increase of £58927 over her basic lump sum whilst commuting £4910 of her pension.

Given that my wife's pension is based on lifetime earnings and not "best of last 3 years" or any other such approach I'm just curious to know whether there is a fund and whether the increased lump sum would go over the 25% fund value

Zelazny

The SPPA has two sets of rules, the 1995 and the 2008 sections. Both are DB schemes, so there is no fund.

The Trustees may assign a nominal fund value for the purposes of this calculation, or it may simply be phrased in terms of funds to align with the governments A day legislation. The fact that she already has an entitlement to tax free cash complicates it slightly, but the maximum amount of cash that I'd expect to see is:
(75000 + [12x25000]) / (1+[0.15*12]) = 375000 / 2.8 = £133,928.57, which is just about the same as in your calculation.

The calculation assures that the amount is not more than 25% of the nominal fund value.