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PCLS: Not as simple as it looks?

27 April 2020

Jessica List, Pension Technical manager, Curtis Banks, considers the often complex rules and conditions applying to the pension commencement lump sum.

Pension commencement lump sum (PCLS), or tax free cash, is one of the most popular and widely understood benefits of a pension. However, that doesn’t mean it’s exempt from the pattern among pensions for every relatively simple rule to be accompanied by a raft of more complex conditions which apply in certain circumstances.

One of the key things which can affect PCLS entitlement is lifetime allowance protection. Each type of protection affects PCLS in different ways, and the difference lies in the way each protection type works.

We’ll start by looking at fixed and individual protection. Both of these protection types work in the same way: they change the reading of other legislation, so that anywhere there is a mention of the ‘standard lifetime allowance’, this should instead be read as that client’s protected lifetime allowance.

When someone crystallises his or her pension and takes a PCLS, the maximum available (based on standard entitlement) is defined in the legislation as the lower of two amounts. The first is a quarter of the amount they are looking to crystallise (or a third of the amount of the pension they will become entitled to, depending on which way you look at it). The second is found by a formula: (CSLA – AAC)/4

CSLA is the standard lifetime allowance at the time of the crystallisation. AAC is the value of previous crystallisations, revalued in line with changes to the lifetime allowance. In other words, the maximum PCLS a person with standard entitlement can take is a quarter of his or her remaining lifetime allowance entitlement. Because individual and fixed protections work by changing the reading of the standard lifetime allowance, CSLA for clients with those protections becomes their protected lifetime allowance. This means that the maximum PCLS they can have is a quarter of their protected lifetime allowance instead of the standard lifetime allowance.

Enhanced protection is the odd one out when it comes to lifetime allowance protection. It doesn’t work by changing the lifetime allowance at all – it works by making those who hold the protection exempt from paying any lifetime allowance charges they would otherwise be subject to. Therefore enhanced protection doesn’t, in and of itself, change a person’s PCLS entitlement. However, it was possible for people to apply to have a form of PCLS protection built into their enhanced protection.

Where that’s the case, the definition of the maximum PCLS available changes. It becomes: (VULSR/VUR) x (LS + AD)

In English, you take the client’s PCLS entitlement at A-Day (6 April 2006) and divide it by their uncrystallised pension rights at A-Day, which gives their PCLS entitlement at A-Day as a percentage. Then you apply that same percentage to the amount they’re currently looking to crystallise. So if the client would have been able to take the equivalent of 10% of their pension as PCLS at A-Day, they’ll still be able to take 10% PCLS now, with no upper limit.

The situation for clients with primary protection is different again. Like enhanced protection, primary protection doesn’t itself affect PCLS entitlement. Primary protection works by changing a person’s lifetime allowance, but not in the same way as fixed and individual protection. The legislation talks about the lifetime allowance in two different ways: an individual’s lifetime allowance, and the standard lifetime allowance. In many cases they are one and the same thing. However, for those with primary protection the distinction is important. Primary protection works by outlining rules to calculate an individual’s lifetime allowance. However, it doesn’t change the reading of the standard lifetime allowance, which is the one used in the normal PCLS calculation. Therefore it increases a person’s lifetime allowance without affecting their PCLS entitlement.

However, like enhanced protection, primary protection can have PCLS protection built into it, which also works by changing the maximum available. There are several layers of formulae behind this one, but what it boils down to is that the client is entitled to the PCLS they were entitled to at A-Day, increased by 20% (in line with lifetime allowance increases, but not reduced in respect of the drops since 2012). To find the client’s PCLS entitlement at any given point, you would also deduct the value of any PCLS already taken since A-Day – also subject to revaluing, of course.

Clients who have primary or enhanced protection without built-in PCLS protection will be subject to the normal PCLS entitlement rules, except that since 6 April 2014 they have been able to read ‘CSLA’ in the formula as £1.5m, instead of the standard lifetime allowance. This makes sure that those individuals do not end up with a lower PCLS entitlement than they would have had at A-Day.

To end on the easiest note: lifetime allowance enhancement factors don’t affect PCLS entitlement at all. Like primary protection, they work by increasing an individual’s lifetime allowance; unlike primary protection, there’s no way of adding separate PCLS protection. This is because enhancement factors are designed for funds which don’t need to be tested against the lifetime allowance – normally because they have already been tested or didn’t benefit from UK tax relief. The idea of the enhancement factor is to effectively exempt those funds from the lifetime allowance by increasing the individual’s lifetime allowance by the same amount, leaving them with their normal lifetime allowance (and PCLS) entitlement untouched.

For most clients, PCLS entitlement will be very straight forward. Even for those whose entitlement is a little trickier to calculate, it’s still one of the best known and appreciated pension benefits.

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