PTM176330 - Lump sum allowance: Enhanced protection: Benefit accrual
Relevant benefit accrual
Relevant benefit accrual in other money purchase arrangements
Relevant benefit accrual in hybrid arrangements
Relevant benefit accrual in defined benefits and cash balance arrangements
The crystallisation value of benefits and transfers for the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements
Relevant benefit accrual in defined benefits arrangements and cash balance arrangements: the appropriate limit
Relevant benefit accrual in defined benefits and cash balance arrangements: the earnings recalculation value
Relevant benefit accrual under enhanced protection: the post-commencement earnings limit
When relevant benefit accrual occurs at a payment of pension or a lump sum
Relevant benefit accrual
Paragraph 13 Schedule 36 Finance Act 2004
Individual with valid enhanced protection obtained prior to the 15 March 2023 can accrue benefits without losing their enhanced protection.
An individual who obtained valid enhanced protection on or after 15 March 2023 can lose their protection as a result of relevant benefit accrual.
The test used to see if relevant benefit accrual has occurred depends on the type of arrangement under which the individual’s benefits are being provided. There are different rules for:
- Other money purchase arrangements, and
- Cash balance arrangements or defined benefit arrangements.
Essentially, the relevant benefit accrual test for other money purchase arrangements is an input test. The payment of a contribution on or after 6 April 2006 to this type of arrangement triggers the loss of enhanced protection but not the payment of benefits.
The relevant benefit accrual test for defined benefits arrangements or cash balance arrangements is an output test. So, the payment of contributions to these types of arrangement does not trigger loss of enhanced protection but the payment or transfer of benefits may cause loss of enhanced protection.
Relevant benefit accrual in other money purchase arrangements
Paragraph 13(a) and 14 Schedule 36 Finance Act 2004
Other money purchase arrangements are money purchase arrangements that are not cash balance arrangements.
For other money purchase arrangements, ’relevant benefit accrual’ occurs when a relevant contribution is made under the arrangement after 5 April 2006.
Any of the following are relevant contributions for the purposes of enhanced protection:
- a relievable pension contribution - a contribution paid by the member or paid by someone else, other than the member’s employer, on behalf of the member (for more information about relievable pension contributions generally, see PTM044100).
- a contribution paid by the member’s employer in respect of the member
- a contribution paid (but not paid by the member or someone else on behalf of the member or by the member’s employer) in respect of the member that is subsequently allocated to the member under the arrangement.
The following contributions are not relievable pension contributions:
- contracted-out rebates and minimum contributions paid into an other money purchase arrangement by HMRC
- contributions paid by the member or someone else (other than their employer) in respect of the member after the member has reached age 75
- life assurance premium contributions
The following do not trigger loss of the enhanced protection:
- minimum payments under section 8 of the Pension Schemes Act 1993 or section 4 of the Pension Schemes (Northern Ireland) Act 1993 or any amount recovered under regulations made in connection therewith - where such payments are being made before 6 April 2006 they may continue.
- contributions that are used to provide life cover under a policy of insurance, on the life of the individual, that existed before 6 April 2006 do not count as relevant contributions specifically where:
- there is no right to surrender any rights under the policy
- the terms of the policy are not varied significantly (and any exercise of rights conferred by the policy is to be regarded for this purpose as a variation) uring the period beginning with 6th April 2006 and ending with the individual’s actual death so as to increase the benefits payable under the policy or extend the period during which benefits are so payable, and
- no benefits are paid, or other payments made, under (or on surrender of rights under) the policy except by reason of the individual’s death
- contributions paid by a sponsoring employer to a relevant hybrid arrangement do not count as relevant contributions where those contributions are solely for providing defined, or cash balance, lump sum death benefits in respect of the individual - for this purpose a relevant hybrid arrangement means a hybrid arrangement under an occupational pension scheme:
- which subsequently becomes an other (that is non-cash balance) money purchase arrangement, and
- under which lump sum death benefits were payable in respect of the individual had the individual dies on 5 April 2006.
The payment of compensation into an other money purchase arrangement after 5 April 2006 could be a relievable pension contribution, triggering loss of enhanced protection. Whether it does so depends upon the nature of the compensation.
Relevant benefit accrual in hybrid arrangements
Paragraph 13(a) Schedule 36 Finance Act 2004
Under a hybrid arrangement the type of benefit provided is not known until benefits are actually provided. So a hybrid arrangement could end up providing benefits as either other money purchase, cash balance or defined benefits (depending on what benefits have been promised).
Contributions to hybrid arrangements may continue after 5 April 2006 without immediate loss of enhanced protection. However, if when benefits crystallise the hybrid arrangement is found to be an other money purchase arrangement, the contributions paid after 5 April 2006 cause loss of enhanced protection. Protection is lost at the point the hybrid arrangement becomes an other money purchase arrangement.
Where one of the potential benefit options under a hybrid arrangement is other money purchase benefits (money purchase benefits that are not cash balance benefits) there are two possible relevant benefit accrual tests that may apply to the arrangement. These are:
- the test for other money purchase arrangements
- the test for defined benefits arrangements or cash balance arrangements
Relevant benefit accrual in defined benefits and cash balance arrangements
Paragraph 13(b), 15(1) - (4) Schedule 36 Finance Act 2004
Payments from a cash balance arrangement or defined benefits arrangement that are either:
- a individual becoming entitled to any pension of lump sum, or
- a permitted transfer to an other money purchase arrangement
trigger a test for relevant benefit accrual. If relevant benefit accrual has occurred enhanced protection is lost.
When does relevant benefit accrual occur?
Relevant benefit accrual occurs when the total value of:
- the pension or lump sum payment and
- permitted transfers to other money purchase arrangements
paid from cash arrangements and/or defined benefits arrangements in respect of the same employment, or from arrangements related to the employment are more than the appropriate limit.
Some retirement benefits schemes are set up for a number of employers that may or may not be associated. Such schemes may provide benefits that are calculated strictly in respect of each employment held by the individual so that the scheme may provide a number of separate pension entitlements. Alternatively, such schemes may provide benefits for a number of employments held by the individual by calculating total benefits for all the employments by reference to the earnings from the last employment held. Where this is the case, the test for relevant benefit accrual and the value of the ‘appropriate limit’ will be applied to the benefits paid in respect of all the employments, as if there were a single employment.
Benefits in other money purchase arrangements are not included in this calculation. Neither the benefits paid nor the value of benefits held in these arrangements on 5 April 2006 is included in the relevant benefit accrual test.
The crystallisation value of benefits and transfers for the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements
Paragraph 15(1) – (3) Schedule 36 Finance Act 2004
In the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements the amount of the payments that is compared to the ‘appropriate limit’ is called the ‘relevant crystallised amount’. The relevant crystallised amount is the total of the crystallised amounts for each ‘relevant event’ - that is entitlement to any pension or lump sum and permitted transfers to other money purchase arrangements.
For a relevant permitted transfer to an other money purchase arrangement the amount crystallised is the total of the:
- amount of sums, and
- market value of assets
held for the purposes of the arrangement that is transferred.
Transfer of crystallised rights
Article 36 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 SI 2006/572
Where:
- a member is in receipt of a scheme pension, and
- sums and assets representing the pension in payment are transferred in connection with the winding-up of the scheme providing the pension
the relevant crystallised amount in respect of the transferred crystallised scheme pension will be nil.
Relevant events occuring at different times
Where relevant events that form part of the total relevant crystallised amount occur at different times the value of the earlier event is not changed. There is no uprating in line with the increase in the standard lifetime allowance to take account of the earlier payment.
Examples of the relevant benefit accrual test for each cash balance and defined benefits arrangements
Andrew applies for enhanced protection on 17 March 2023, he is granted a valid EP certificate.
Andrew has pension rights under four different arrangements. The benefits relate to two separate employments. On 5 April 2006 these are valued at:
Arrangement 1 - defined benefits: £750,000
Arrangement 2 - cash balance: £250,000
Arrangement 3 - other money purchase: £50,000
Arrangement 4 - defined benefits: £300,000
Arrangements 1 to 3 relate to employer A. Arrangement 4 is in respect of employer B.
On 20 September 2024, Andrew decides to take benefits from arrangement 1. The value of this benefit crystallisation event is £900,000.
For the relevant benefit accrual test the crystallised value of the benefits paid from Arrangement 1 (£900,000) is compared to the value of all benefits provided by cash balance arrangements and defined benefits arrangements for employer A on 5 April 2006 (£1 million).
The amount of those rights on 5 April 2006 - £1 million - is re-valued in line with the legislation to give the ‘appropriate limit’. The £900,000 crystallised is less than the value of the protected defined benefits and cash balance benefits for employer A, so there is no relevant benefit accrual.
On 1 February 2025, Andrew decides to take benefits from Arrangement 2. The crystallised value of these benefits is £350,000. This means Andrew has now crystallised total benefits for employer A worth £1.25 million. The £1.25 million benefits taken is compared to the re-valued amount of the protected defined benefits/cash balance benefits for employer A on 5 April 2006 - the appropriate limit.
The appropriate limit is found to be £1.22 million. As the total benefit taken are more than the appropriate limit there has been relevant benefit accrual and Andrew loses enhanced protection.
Relevant benefit accrual in defined benefit arrangements and cash balance arrangements: the appropriate limit
Paragraphs 15(4) – (11), 16 and 17 Schedule 36 Finance Act 2004
Regulation 3 The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangement and Enhanced Protection) Regulations 2006 - SI 2006/130
The ‘appropriate limit’ is the greater of two values:
- the indexed amount
- the earnings recalculation amount.
Where an individual dies having registered for enhanced protection and a lump sum death benefit is paid, the value of the ‘appropriate limit’ may need to be recalculated.
The indexed amount
The indexed amount is the value of the pension rights in the arrangement(s) on 5 April 2006, as valued by paragraphs 8 and 9 Schedule 36 Finance Act 2004 are increased by an indexation percentage to the date of the benefit crystallisation event or permitted transfer.
The indexation percentage is the greatest of:
- an annualised increase of 5 per cent from 5 April 2006, or
- the percentage increase in the Retail Price Index (RPI) from April 2006 to the month in which the relevant event or the permitted transfer occurs, or
- for contracted-out rights, rights subject to revaluation or preserved rights, an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2002 – SI 2006/130.
The total value of benefits crystallised/transfers made is compared to the indexed amount to see whether or not the relevant benefit accrual has occurred.
The earnings recalculation amount
The earnings recalculation amount is the value of the pension rights in the arrangement on 5 April 2006, as valued by paragraphs 8 and 9 Schedule 36 Finance Act 2004, uprated by ‘the earnings re-calculation value’. The value of the pension rights on 5 April 2006 is calculated using pensionable earnings up to that date. Under the earnings re-calculation value, earnings paid after 5 April 2006 can be used to increase the value of pension rights on that date. The value of pensionable earnings may be affected by the post-commencement earnings limits.
The earnings recalculation value is set at the point of the first benefit crystallisation event or permitted transfer to an other money purchase arrangement. See below for more information on how the earnings recalculation works.
Relevant benefit accrual in defined benefits and cash balance arrangements: the earnings recalculation value
Paragraph 15(6) – (11), 16 and 17 Schedule 36 Finance Act 2004
The earnings recalculation value is a calculation of the value of the pension rights as at 5 April 2006 using two assumptions. These are that:
- the pension rights under the arrangement are calculated as if the individual’s benefits were payable on 5 April 2006 to the individual as if he were the age he had attained when he first takes benefits under the arrangement or transfers out of the arrangement by means of a ‘permitted transfer’ to an other money purchase arrangement; and
- the amount of the earnings to be used in the calculation of the pension rights is the lesser of:
- pensionable earnings immediately before the date of first taking benefits under the arrangement or the date of the ‘permitted transfer’, using the definition of such earnings as applied under the arrangement on 5 April 2006; and
- the ‘post-commencement earnings limit’ as defined in paragraphs 15 and 16 Schedule 36 Finance Act 2004. This limit does not apply to the calculation of pension rights in statutory schemes and the Parliamentary pension scheme as defined in paragraph 1(1) (c) and (e) Schedule 36 Finance Act 2004 respectively.
If the individual has rights in a number of related arrangements the calculation is made when the first benefit crystallisation event or permitted transfer to an other money purchase arrangement occurs in any of the arrangements.
Permitted transfers after 5 April 2006
Where there is a relevant permitted transfer to a cash balance arrangement or defined benefits arrangement the earnings recalculation works by treating the new arrangement as if it were the same as the old arrangement. Where there is a change of employer and a transfer is made in connection with a relevant business transfer the new employment is treated as if it were the same as the old employment. This enables earnings with the new employer to count towards the earnings recalculation test.
How the earnings recalculation works for a defined benefit arrangement
Paragraph 15(6) to (11), 16 and 17 Schedule 36 Finance Act 2004
For the earnings recalculation in a defined benefits arrangement the relevant pensionable earnings received after 5 April 2006 are used to calculate allowable benefits. Pensionable service to 5 April 2006 is used, as is the scheme accrual rate as it stood on 5 April 2006.
Pensionable service accrued after 5 April 2006 cannot be included in the calculation. Any change in the scheme accrual rate after 5 April 2006 is ignored. Any change in the scheme definition of pensionable salary after 5 April 2006 is ignored.
If the member takes benefits before or after their expected retirement date the amount of benefits is adjusted to take account of any reduction or increase required by the scheme rules as they were on 5 April 2006.
Example
On 5 April 2006 Robert has 29 years pensionable service and his benefits accrue at a rate of 1/60th of pensionable salary for each year of pensionable service.
Robert’s pensionable salary is £150,000. So, on 5 April 2006 Robert has protected accrued benefits of £1,450,000
29/60 x £150,000 = £72,500pa (x 20) = £1,450,000.
On 5 April 2026 later Robert first crystallises benefits. Robert’s pensionable earnings are now £225,000. This gives a pension worth
29/60 x £225,000 = £108,750pa
However, Robert is retiring 2 years before his normal retirement date and the scheme rules require Robert’s pension to be reduced by 4 per cent for each year it is paid early.
The pension that Robert will receive will be reduced by 8 per cent to account for the fact that it is being paid 2 years earlier than expected. So for the earnings recalculation Robert will receive benefits worth £2,001,000.
£108,750 - 8% = £100,050 x 20 = £2,001,000
Using the earnings recalculation the ‘appropriate limit’ is £2,001,000.
An arrangement may hold a transfer-in on an ‘added years’ basis where the pensionable service credited for the transfer has been calculated using uncapped earnings even though the individual’s earnings are capped for current service. In these circumstances when making the earnings recalculation the number of ‘added years’ credited for the transfer-in may be calculated using capped earnings.
How the earnings recalculation works for cash balance arrangements
For a cash balance arrangement the pensionable earnings received after 5 April 2006 are used to determine a revised capital value. The capital value is then adjusted to allow for any reduction or increase required by the scheme rules if the benefits are taken either before or after the member’s normal retirement date.
Example
Henry is a member of a cash balance arrangement where he is promised that an amount of 20 per cent of his final pensionable salary for each year of pensionable service will be made available to provide benefits.
On 5 April 2006, Henry aged 54 has accrued 30 years of pensionable service and his pensionable salary is £250,000. His benefits rights on 5 April 2006 are therefore £1,500,000 (£250,000 x 20% x 30).
On 5 April 2026, Henry, now aged 74 takes benefits. His normal retirement age (NRA) under the scheme is 60. He took no benefits at age 60 and stayed in service. The scheme rules award actuarial increases to benefits deferred past NRA. (The scheme calculates the value of benefits at age 60 using Henry’s pensionable salary at that point and then actuarially increases the benefits for the period age 60 to 74.)
The actuarial increase calculated with respect to the scheme rules on 5 April 2006 increases the value of the deferred benefits to £2 million. This will be the ‘appropriate limit’ using the earnings recalculation.
Where the benefits promised under a cash balance arrangement are not dependent on earnings the earnings recalculation will have no effect. The appropriate limit will be the indexed amount.
Relevant benefit accrual under enhanced protection: the post-commencement earnings limit
Paragraph 15(8), 16 and 17 Schedule 36 Finance Act 2004
There are two different definitions of the ‘post-commencement earnings limit’. The definition used depends on whether or not on 5 April 2006 the individual was a ‘capped’ member under any scheme providing cash balance or defined benefits in respect of the employment for which relevant benefit accrual is being tested.
A capped member is someone who was subject to the 1989 earnings cap. Other known terms for such a member are 1989 member, post-1989 member or class A member.
Paragraph 16 Schedule 36 defines what the post-commencement earnings limit is for capped members.
The post commencement earnings limit for non-capped members is prescribed by paragraph 17 Schedule 36.
Schemes that the post-commencement earning limit does not apply to
The post-commencement earnings limit does not apply to:
- a relevant statutory scheme (as defined by Section 611A ICTA 1988)
- a scheme treated by HMRC as if it were a relevant statutory scheme,
- a parliamentary scheme or fund mentioned in section 613(4)(b) to (d) ICTA 1988.
The post-commencement earning limit for capped members
Paragraph 16 Schedule 36 Finance Act 2004
The post-commencement earnings limit for capped members is the lower of:
- £135,000, and
- The individual’s highest earnings from the employment being pensioned in any consecutive 12 months in the three year-period ending with the earlies of:
- The first relevant event,
- The individual leaving the pensionable employment to which the defined benefits arrangement or cash balance arrangement relates, and
- The individuals death.
The first relevant event is the earlier of the first pension or lump sum payment or the first relevant permitted transfer to an other money purchase arrangement.
Where the individual died or left pensionable employment before the first relevant event the amount of earnings can be increased from the date of death or leaving the pensionable employment (as appropriate) until the date of the first relevant event.
The increase is the greater of:
- An annualised increase of 5%, or
- The percentage of the RPI, or
- For contracted-out rights, rights subject to revaluation, or preserved rights an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130.
The post-commencement earnings limit for non-capped members
Paragraph 17 Schedule 36 Finance Act 2004
The post commencement earnings limit for a non-capped member is the individual’s highest earnings from the employment being pensioned in any consecutive 12 months in the three-year period ending with the earliest of:
- the first relevant event,
- the individual leaving the pensionable employment to which the defined benefits arrangement or cash balance arrangement relates, and
- the individual’s death,
as long as the amount is not more than £135,000.
Where the amount is more than £135,000 the post-commencement earnings limit for non-capped members is the greater of:
- £135,000, and
- Total earnings from the pensionable employment for the three-year period ending with the earlies of the three dates shown above divided by three.
The first relevant event is the earlier of the first pension or lump sum payment or the first relevant permitted transfer to an other money purchase arrangement.
Where the individual died or left pensionable employment before the ‘first relevant event’ the amount of earnings can be increased from the date of death or leaving the pensionable employment (as appropriate) until the date of the ‘first relevant event’. The increase is the greater of:
- an annualised increase of 5 per cent, or
- for contracted-out rights, rights subject to revaluation, or preserved rights: an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130, or
- the percentage increase in the Retail Price Index.
When relevant benefit accrual occurs at a payment of pension or a lump sum
Individuals that have valid EP dated on or after 15 March 2023 can lose their enhanced protection due to benefit accrual.
A scheme administrator will know when a lump sum or lump sum death benefit is paid that enhanced protection will be lost where there is relevant benefit accrual. If the administrator knows enhanced protection will be lost, they should not pay out benefits on the basis that enhanced protection applies. If a scheme administrator pays a lump sum or lump sum death benefit without deducting any income tax they could have no ‘good faith’ defence against any tax liabilities and penalties as they knew that enhanced protection would not apply because of the benefit accrual triggering a loss of protection.
How scheme administrators deal with this issue will vary from scheme to scheme as there is no prescribed process. However, scheme administrators should be aware that when an individual notifies HMRC of their entitlement to both primary and enhanced protection, because enhanced protection takes precedence over primary protection their certificate will show entitlement to enhanced protection and confirm the dormant primary protection. Individuals may have valid primary protection but not yet have evidence of this. On the loss of enhanced protection such an individual would revert to primary protection. They would need to notify HMRC of this who will then issue a revised certificate showing the appropriate primary protection factors for that individual.
Administrators may choose to notify individuals that when an individual has a pension or lump sum payment that results in benefit accrual, they will lose enhanced protection and that if they have primary protection, they should obtain a revised certificate from HMRC. On receipt of details of the revised certificate administrators will then be able to pay benefits under the primary protection rules.
For more information about relevant benefit accrual please see the National Archives.