Lump Sum Options - Commutation of Pension Benefits

When entering Final Salary benefits, one of the options for setting the appropriate payment of tax-free cash (found under Lump Sum Options) is Commutation. Under this option, one will need to know the scheme's commutation factor. You are able to commute income so as to provide up to 25% of the crystallised benefits as tax-free cash, in accordance with the formulae provided below.

The software applies the following commutation formula:

PCLS = Pension / [3/20 + 1/Commutation Factor]
Residual Pension = Full Pension - [PCLS/Commutation Factor]

This PCLS calculation is predicated on the assumption that tax-free cash is to be valued at 25% of the member's crystallised benefits (NB: for the purposes of the LTA, a factor of 20 is applied to final salary benefits). So, to take the example of an individual who has deferred final salary benefits, with income payments estimated at 10,000 per annum, and with a scheme commutation factor of 24:

PCLS = 10,000 / [3/20 + 1/24]. Therefore, PCLS = 52,174.

The residual pension, then, is calculated as follows:

10,000 - [52,174/24]. Residual pension, then = 7,826 meaning that the individual has given-up a pound of income for each 24 of tax-free cash.

The total value of the crystallised benefits = [Residual Pension x 20] + PCLS

The calculations and amounts shown above are consistent with having selected the Maximum option. Alternatively, one can select a Fixed Amount of tax-free cash (up to the maximum), in which case, just enough income will be commuted as is needed to generate the desired amount of tax-free cash.

NB: This method will not work for schemes with Additional Voluntary Contributions (AVCs).