PTM053710 - Annual allowance: pension input amounts: adjustments to closing values: further detail
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Defined benefits and cash balance arrangements: examples of adjustments to closing values
Transfers
Example of adjustment of closing value for a transfer
Example of adjustment of closing value for a pension credit
Example of adjustment of closing value for a benefit crystallisation event (BCE)
Defined benefits and cash balance arrangements: examples of adjustments to closing values
Sections 232 and 236 Finance Act 2004
The guidance on this page applies to defined benefits and cash balance arrangements and hybrid arrangements that might provide defined benefits or cash balance benefits.
PTM053300 (for defined benefits arrangements) and PTM053400 (for cash balance arrangements) have more details about the adjustments that must be made to closing values.
The guidance on this page does not apply in the case of a ‘block transfer’ from one registered pension scheme to another.
See PTM053720 for details about ‘block transfers’.
Transfers
If there is a transfer of sums or assets (a ‘transfer payment’) from one registered pension scheme to another involving a defined benefits arrangement or cash balance arrangement, an adjustment is made to take account of the transfer payment.
In the case of a transfer-out from a defined benefits or cash balance arrangement, there is an adjustment to determine whether there is an increase in pension savings in the transferring arrangement.
In the case of a transfer-in to a defined benefits or cash balance arrangement, there is an adjustment to determine whether there is an increase in pension savings in the receiving arrangement.
Transfer out
The pension savings amount, or pension input amount, for the transferring scheme is valued by adding back to the closing value
- in the case of a cash balance arrangement, the amount of the reduction in rights available to provide benefits under the arrangement relating to the transfer payment,
- in the case of a defined benefits arrangement, the amount of pension (and separate lump sum if applicable) that relates to the transfer payment.
Transfer in
The pension savings amount, or pension input amount, for the receiving scheme is valued by subtracting from the closing value:
- in the case of a cash balance arrangement, the amount of the increase in rights available to provide benefits under the arrangement relating to the transfer payment
- in the case of a defined benefits arrangement, the amount of pension (and separate lump sum if applicable) that relates to the transfer payment.
General requirements for transfer payments out and in
There must be a direct link between the amount of the transfer payment and the amount added back or subtracted from the closing value for the purpose of the pension input amount calculation. The amount added back or subtracted is so much of the decrease or increase in:
- for a defined benefits arrangement, the pension (and, if applicable, separate lump sum)
- for a cash balance arrangement, the rights available to provide benefits
that is solely attributable to the amount of the sums and assets transferred. This would usually be determined by normal actuarial practice allowing for the specific circumstances.
If the increase in pension savings in the receiving scheme relating to the transfer payment is augmented so that the increase is over and above the amount of increase that the transfer payment was capable of funding, the ‘excess’ amount of the increase is included in the pension input amount calculation.
In the case of a transfer out the individual will normally be given a ‘cash equivalent transfer value’ (CETV) of the benefit rights that had built up by the time of the transfer. Where the individual is given a reduced CETV, such as due to underfunding in the transferring pension scheme, it is likely that a lesser amount will be added back to the closing value compared to the amount that would have been added back had a full CETV been given.
Transfers within the same pension scheme
The principles above also apply when there is a transfer between arrangements within the same registered pension scheme (except for ‘block transfers’ within the same scheme - see PTM053720).
Pension debits and pension credits
There are similar rules to take account of pension sharing orders on divorce, where the value transferred is referred to as a pension credit from the same or another registered pension scheme.
Example of adjustment of closing value for a transfer
Tundi is a member of a final salary scheme (a defined benefits arrangement).
His benefits build up at a rate of a pension of 1/80th (and a separate lump sum of 3/80ths) of final pay for each year of scheme membership.
Immediately before the start of his pension input period, Tundi has 19 years scheme membership and his ‘final pay’ is £65,000. For the purpose of this example, the annual increase in CPI to the September before the tax year is 3.2 per cent.
During the pension input period in question Tundi changes jobs. He joins his new employer’s career average scheme (which is also a defined benefits arrangement). Tundi earns a pension of 2 per cent of his annual pay rate for the year from this scheme. The scheme does not give a separate lump sum. If Tundi wants to take a lump sum when he retires he must give up (commute) pension to get the lump sum.
Tundi transfers his benefits from his old final salary scheme (scheme 1) into the new career average scheme (scheme 2).
Calculating the opening values
Tundi’s opening value for scheme 1 (the final salary scheme) is calculated as:
Find amount of annual pension
19/80 x £65,000 = £15,437.50
Multiply annual rate of pension by flat factor of 16
£15,437.50 x 16 = £247,000
Add amount of separate lump sum
£247,000 + (19 x 3/80 x £65,000) = £293,312.50
Increase by CPI
£293,312.50 x 1.032 = £302,698.50
So the opening value for scheme 1 is £302,698.50.
The opening value for scheme 2 is nil (as Tundi is a new member at the start of the pension input period for the arrangement under scheme 2).
Calculating the closing values
The closing values for both scheme 1 and scheme 2 need to be adjusted because of the transfer value. If this was not done the pension input amounts for both schemes would not be correct. This adjustment is only needed for the pension input period that the transfer takes place in.
Without an adjustment the closing value for scheme 1 would be nil (as all the benefits have been given up in exchange for a transfer out). The amount of Tundi’s benefit rights in scheme 1 that he exchanged for the transfer payment is added back to the closing value for scheme 1. At the point Tundi arranged the transfer he had built up a pension of £16,800 and a separate lump sum of £50,400 in scheme 1.
This means that the closing value for scheme 1 is:
Find amount of annual pension
£16,800
Multiply annual rate of pension by flat factor of 16
£16,800 x 16 = £268,800
Add amount of separate lump sum
£268,800 + £50,400 = £319,200
The closing value for scheme 1 is £319,200.
In scheme 2 the transfer payment from scheme 1 was able to fund (or ‘purchase’) a pension equivalent of £18,300. In the pension input period for scheme 2 Tundi has earned a pension of £800 from his new job. This makes his total annual pension under the scheme £19,100. Without an adjustment to take account of the transfer in, the closing value for scheme 2 would be £305,600 (£19,100 x 16).
To find the closing value for scheme 2 the effect of the transfer is neutralised because the pension equivalent of £18,300 was no more than the amount that the transfer payment was capable of purchasing in scheme 2. The closing value for the pension input period is based only on the rights built up under scheme 2 - that is a pension of £800.
So the closing value for scheme 2 is:
Find amount of annual pension
£800
Multiply annual rate of pension by flat factor of 16
£800 x 16 = £12,800
Add amount of separate lump sum
£12,800 + £0 (there is no separate lump sum) = £12,800
The closing value for scheme 2 is £12,800.
Finding the pension input amounts
Tundi’s pension inputs from his defined benefits arrangements are:
For scheme 1: closing value (£319,200) - opening value (£302,698.50) = £16,501.50
For scheme 2: closing value (£12,800) - opening value (nil) = £12,800
As Tundi is not a member of any other arrangement his total pension input amount for the tax year is £29,301.50 (£16,501.50 + £12,800).
For future tax years, the pension input amount is calculated as normal, with no adjustment for the transfer.
Example of adjustment of closing value for a pension credit
Angela is a member of a cash balance arrangement. Angela gets 15 per cent of her annual pay rate added to her promised pension pot every year. Immediately before the start of the pension input period Angela’s pension pot has a value of £180,000. For the purpose of this example, the annual increase in CPI to the September before the tax year is 2.5 per cent.
Calculating the opening value
The opening value for the cash balance arrangement is:
£180,000 x 1.025 = £184,500
During her pension input period Angela gets a pension credit from a pension sharing order. This pension credit has a value of £62,500.
Calculating the closing value
At the end of the pension input period the value of Angela’s pension pot is £247,750. However this amount includes the pension credit from another registered pension scheme. If no adjustment is made to the closing value Angela’s pension input would not reflect the amount she has actually built up over the pension input amount. This adjustment is only needed for the pension input period that Angela gets the pension credit.
The amount of the pension credit is taken off the closing value (so £247,750 - £62,500). This means Angela’s closing value is £185,250.
Finding the pension input amounts
Angela’s pension input under the cash balance arrangement is:
Closing value (£185,250) - opening value (£184,500) = £750.
For future years, the pension input amount is calculated as normal, with no adjustment for the pension credit.
Example of adjustment of closing value for a benefit crystallisation event (BCE)
Julia belongs to a pension scheme that gives her a pension of 1/60th pensionable pay for each year of scheme membership. The scheme does not give her a separate lump sum. If Julia wants to take a lump sum when she starts to draw benefits she will have to give up (commute) part of her pension.
Immediately before the start of the pension input period Julia has built up an annual pension of £26,500.
During the pension input period Julia reaches the scheme’s pension age and decides to start taking some of her benefits. She also wants to keep working and keep building up benefits. Julia’s pension scheme allows her to do this. Julia takes a pension of £12,000 and a lump sum of £80,000. To get her lump sum Julia had to give up £6,000 pension. So if Julia had not taken a lump sum she would be getting a pension of £18,000.
At the end of the pension input period Julia has £10,000 pension still to take.
For the purpose of this example, the annual increase in CPI to the September before the tax year is 3 per cent.
Calculating the opening value
Julia’s opening value for the scheme is calculated as:
Find amount of annual pension
£26,500
Multiply annual rate of pension by flat factor of 16
£26,500 x 16 = £424,000
Add amount of separate lump sum
There is no separate lump sum = £424,000
Increase by CPI
£424,000 x 1.03 = £436,720
Julia’s opening value is £436,720.
Calculating the closing value
Without any adjustment for the BCE Julia’s closing value would be £160,000 (£10,000 x 16). This does not reflect the fact that Julia has built up extra pension benefits over the pension input period. An amount equivalent to the BCE needs to be added back into the closing value. The adjustment to the closing value is made at step 1 by adding back the amount of pension taken. This is the gross amount of pension; the amount that would have been paid to Julia if she had not taken a lump sum. This is £18,000.
Find amount of annual pension
Remaining pension + Pension taken
£10,000 + £18,000 = £28,000
Multiply annual rate of pension by flat factor of 16
£28,000 x 16 = £448,000
Add amount of separate lump sum
There is no separate lump sum = £448,000
Julia’s closing value is £448,000.
Finding the pension input amount
Julia’s pension input amount is the difference between her closing value and her opening value. This is:
£448,000 - £436,720 = £11,280
For future years, the pension input amount is calculated as normal, with no adjustment for the BCE.