Defined Benefit pension Lump Sum and tax

dunstonh

Sandtree said:

Albermarle said:

Tax Free Cash Lump Sum is normally 25% of the value of the pension

That only applies to DC pension pots .

The OP is asking about a Defined Benefit scheme and a previous poster already explained

There is no 25% TFLS with a DB pension, there is a Pension Commencement Lump Sum.

This is based on the scheme rules (which must adhere to legislation).

Ok, have seen advisors refer to both DC and DB as a tax free cash lump sum but that could be lax wording from them, unless it changes again if the pension becomes a deferred annuity?

Both are often called tax free cash.  The name of the tax free cash has changed multiple times over the years but its not the name that is the issue.  It was the reference to 25% tax free cash that was wrong with DB schemes.  Only DC schemes get 25% tax free cash (caveats apply as some can get more or less).  DB schemes get a scheme-specific calculation applied to them to calculate the lump sum available.

hyubh

Dazed_and_C0nfused said:

There is no 25% TFLS with a DB pension

Oh yes there is... in covering pensions legislation in respect of the tax free limit + how the LGPS regulations define the maximum lump sum that can be taken (25% the LTA value of the crystallised pension and lump sum). Denying this will just confuse the OP, since the scheme literature received will very likely refer to it, prominently...

QrizB

hyubh said:

Dazed_and_C0nfused said:

There is no 25% TFLS with a DB pension

Oh yes there is... in covering pensions legislation in respect of the tax free limit + how the LGPS regulations define the maximum lump sum that can be taken (25% the LTA value of the crystallised pension and lump sum). Denying this will just confuse the OP, since the scheme literature received will very likely refer to it, prominently...

OP hasn't mentioned LGPS, so far as I can tell. Are there reasons to think that is the scheme they are referring to?

hyubh

QrizB said:

hyubh said:

Dazed_and_C0nfused said:

There is no 25% TFLS with a DB pension

Oh yes there is... in covering pensions legislation in respect of the tax free limit + how the LGPS regulations define the maximum lump sum that can be taken (25% the LTA value of the crystallised pension and lump sum). Denying this will just confuse the OP, since the scheme literature received will very likely refer to it, prominently...

OP hasn't mentioned LGPS, so far as I can tell. Are there reasons to think that is the scheme they are referring to?

Opening line of the very first post: 'My Husband turns 60 next month and has an old local government pension due.'

Secret2ndAccount

hyubh has a very valid point. If OP is able to commute more, or less pension into a lump sum, what is the upper limit to that lump sum?  Hey presto - it's 25%. No, there isn't a pot for DB pensions, but there is a method for HMRC to determine the lifetime value of the pension. 25% of that (LTA aside) is the upper limit for the lump sum. 
Those who have made AVC's often cash in AVC to top up their DB lump sum to the 25% limit. It maximises the tax free cash with minimum effect on the guaranteed-for-life annual DB payout.
So, to the OP, your husband can receive tax free cash to the lower of
i) the upper limit set by the scheme rules (it varies, but there will be a maximum amount he is allowed to commute)
ii) 25% of the lifetime value of the pension

If you want a good idea of the lifetime value, take the baseline offer - the default lump sum and default pension. Now multiply the annual pension x 20 and add the lump sum. That's your lifetime value, and 25% of that would be the maximum permitted lump sum by HMRC, all of which would be tax free. It's not a perfect calculation, but will be close.

drummersdale

Silvertabby said:

Yes, the commutation rate of 1 :12 isn't good, but in this case it's maximum tax free cash versus maximum pension that would be taxed at 40%.

Deferring the payment wouldn't work - increases for late payment only kick in from the scheme NRA (65) so OP's husband would just be foregoing up to 5 years of pension payments.

So does this mean that although the commutation rate isn’t that great at 1:12 the fact that it’s tax free is a plus, at least?

Secret2ndAccount

drummersdale said:

Silvertabby said:

Yes, the commutation rate of 1 :12 isn't good, but in this case it's maximum tax free cash versus maximum pension that would be taxed at 40%.

So does this mean that although the commutation rate isn’t that great at 1:12 the fact that it’s tax free is a plus, at least?

Still not that great IMO. OP's husband is 60. Let's say he lives to 85 which is about average. He can receive a 12,000 lump sum in exchange for giving up 1,000 in pension. After 40% tax, that's 600 in pension for 25 years, or 15,000 in total.  So the commutation rate is so bad, that you are still likely to end up worse off.  And you are giving up an index-linked (presumably), lifelong guaranteed income in exchange for a bird in the hand. You had better have good use for that cash lump sum...
As a 40% taxpayer, it gets the two options at least somewhere in the same ballpark, so you would want to start asking yourself about your specific case:
What if the pensioner dies? The cash lump sum is part of his estate, and likely passes to his wife or children free of inheritance tax. A pension would likely come with a spouse's pension, but you need to consult the rules about how commutation affects the amount of Spouse's Pension. If the spouse goes first, the children likely get nothing from the pension.
Do you want to spend the money now, in your sixties, and you have enough other provision to be comfortable in your eighties? You might be okay with the lower total payout in exchange for getting it now.

Secret2ndAccount

If you are only a 20% taxpayer in retirement, the 12:1 commutation is a bad deal, and one which many people jump for because it's a once in a lifetime chance to receive such a large sum. You should take the smallest lump sum you can live with, and look forward to the annual payout for the rest of your life. The considerations above still apply, but the scales are tipped 20% further towards leaving the money in your pension.

ukdw

If the 40% tax liability is a temporary problem there may be better ways to address it than a permanent lowering of the DB pension annual amount,

If OPs husband doesn't need the DB tax free lump sum, and they haven't already maxed out pension contributions, then additional company or SIPP contributions could potentially be a way to balance out the new taxable DB income and therefore stop it being liable for 40% tax.

drummersdale

Secret2ndAccount said:

If you are only a 20% taxpayer in retirement, the 12:1 commutation is a bad deal, and one which many people jump for because it's a once in a lifetime chance to receive such a large sum. You should take the smallest lump sum you can live with, and look forward to the annual payout for the rest of your life. The considerations above still apply, but the scales are tipped 20% further towards leaving the money in your pension.

Thanks very much for the response - I suppose it comes back to the "Jam today or tomorrow" argument which is a common theme on this forum - 85 may be the average but I know very few 85 year olds in my circle or my family but equally I wouldn't want to think "I wish I hadn't taken the bigger lump sum" when I'm sitting in my HSL chair aged 85...good to have different takes on the issue though and to see the impact of any decision in cold hard numbers.  Thanks again.