NIM02770 - Class 1 NICs: Earnings of employees and office holders: retirement benefits schemes from 6th April 2006: employer-financed retirement benefits schemes: payments from such schemes: authorised member payments:
Pension commencement lump sums: amount that can be disregarded
Paragraph 10(4)(b), (5)(b) and (6)(a)(ii) and (b) of Part 6 of Schedule 3 to the Social Security (Contributions) Regulations 2001 (as inserted by regulation 8(6) of the Social Security (Contributions) (Amendment No. 2) Regulations 2006)
Paragraphs 1(2) and 2 of Schedule 29 to Finance Act 2004, as modified by paragraph10(6)(a)(ii) and (b) above
As mentioned in the final bullet in NIM02769, there is a limit on the amount of a pension commencement lump sum (“PCLS”) that can be disregarded in the calculation of earnings. That limit is referred to in paragraph 10(6) as “the permitted lump sum” (“PLS”).
The calculation of the PLS is based broadly on that used for calculating the maximum amount of a PCLS that may be paid tax-free - in broad terms, roughly 25% of the value of an individual’s pension rights (paragraph 2 of Schedule 29; RPSM09104220).
Where the amount of the PCLS exceeds the amount of the PLS, no amount of it can be disregarded in the calculation of earnings.
The PLS is the higher of:
MVF=4 and LS + (MAP x 20) = 4
where:
MVF is the market value of the employee’s employer-financed retirement benefits scheme (“EFRBS”) fund at the time the benefit is paid to the employee
LS is the amount of the lump sum
MAP is the maximum annual pension which could be paid to the employee under the arrangement.
Example
The MVF of employee A’s EFRBS fund is £100,000. The amount of the PCLS is £25,000. The MAP is £10,000 a year.
The PLS (ie, the amount that can be disregarded in the calculation of earnings) is the higher of:
£100,000 ÷ 4 = £25,000 and
£25,000 + (£10,000 x 20) = £225,000 ÷ 4 = £56,250
As the amount of PCLS - £25,000 – is less than the PLS - £56,250 – the whole amount of the PCLS can be disregarded in the calculation of earnings.