Rules on valuing commuted pension for LTA purposes

timodell

I have one DB pension of £16,611.18 for which I have been given the option of taking a lump sum of £91,765,67 plus a reduced pension of £13,764.85. Clearly, if I chose not to take the lump sum, the pension would be valued at 20*£16,611.18 (or £332, 223.60) for LTA purposes. But what happens if I take the lump sum and then build my DC pot to £667,776.4 (let's ignore the indexation of the LTA cap for the purposes of simplicity) with my other SIPP manager and then try and crystalise it? As the combined LTA value is exactly £1m, I should be immune from an LTA charge, but the combined lump sums would be over the implied cap of £250,000 - so would the second crystallisation be subject to an LTA charge or would I have the tax-free lump sum limited to £250,000-£91,765.67)? If either of these happen, I am clearly not fully benefitting from the lump-sum released from the DB pension, so can I ask the scheme actuaries to limit the "tax-free" lump sum to 25% of the LTA value £332,223.60 (ie £83,055.9) and therefore, presumably, retain a higher DM pension of approximately £14,035?

anselld

If you take the lump sum the LTA valuation will be 20*13,764 + 91,765, ie 367,045 which would consume whatever % of LTA that represents at the time of crystallisation. The remaining LTA % would then be available when you decide to crystallise the SIPP.

Silvertabby

Either your scheme offers an incredibly generous commutation factor (over 1:32), or your figures are wrong. Is there not an automatic lump sum with your £16,611.18 pension option?

The standard option of £16,611.18 plus an automatic lump sum of £49,833.54 (3 x pension) would make more sense. Commutation factor apart, £91,765,67 is more than 25% of just 20 x £16,611.18:

1: £16,611.18 x 20 =£332,223.60 x 25% = £83,055.90

2: £332,223.60 + £49,833.54 = £382,057.14 x 25% = £95,514.29

Commuted pension/additional lump sum would be adjusted in line with the scheme commutation rate (a much more believable 1:16?).

timodell

The commutation rate is as stated (ie 1:32), but I will be taking the pension early (at 59 years 3 months) which might partly explain the generosity. But can I just check the LTA calculation again please - I have been told that if you are in the same scheme at the same age but in the opposite position and have a DC (AVC) pot sitting alongside a DB entitlement then you can "reverse-commute" from DC into additional scheme pension at a rate of 40:1. Example figures are basic scheme pension of £12,758.66 and DC pot of £301,113 (which could be moved to another SIP provider and converted into a drawdown pot implying an LTA valuation of £255,173.20 + £301113 = £556,286).




Option 2 is to convert the whole DC pot into an additional pension of £7,451.45 (with an LTA impact of (£12,758.6 + £7,451.45) * 20 = £404,202.20 according to the scheme actuaries)


Option 3 would be to take a tax-free lump sum of £139,071.55 and an additional scheme pension of £4,009.94 (although no LTA impact for this is quoted it will presumably be somewhere in between). Are these methods for calculating LTA impacts right? And, if so, it makes it hideously complicated to assess the trade-off between taking tax-free lump-sums in the conventional way or commuting into taxable additional pension but using up much less LTA and thus avoiding potential LTA penalty charges in the future...

anselld

LTA calculation is against the post-commutation figures and will be 20*pension plus lump sum.

That is simple enough.

Simplistically 32x commutation rate is likely to be good value. 40x reverse commutation is unlikely to be good value.

The fact that the LTA consideration is the reverse in terms of value is inevitable given the way the calculation works.

If you try to optimise tax free benefit you will be in danger of allowing the tail to wag the dog.

timodell

anselld wrote: »

Simplistically 32x commutation rate is likely to be good value. 40x reverse commutation is unlikely to be good value.

Thanks. But while you say that 1:40 is not a good rate for an annuity, the best I can find on the open market are about 1:45, and that assumes no spouses benefit or guarantee period

anselld

timodell wrote: »

Thanks. But while you say that 1:40 is not a good rate for an annuity, the best I can find on the open market are about 1:45, and that assumes no spouses benefit or guarantee period

Fair enough your choice. I would personally prefer drawdown over a 2.5% annuity but if you like that option it is certainly economical on LTA.