Neil MacGillivray: How about this for a DB dilemma?  

Since the Budget and subsequent legislation, I’ve had many conversations with advisers on the implications for clients and what opportunities the changes could afford them.

In my role, I tend to get asked for opinions and guidance on less common scenarios, which often relate to wealthier individuals.

While I accept many advisers won’t come across such situations, or indeed have any clients that fall into these categories, it’s still worth reflecting on them.

One scenario that came up recently was with an adviser’s client who was fortunate enough to be a deferred member of a sizeable defined benefit (DB) arrangement, who also had accrued a large Sipp fund. They had fixed protection 2016, with a personal lifetime allowance (LTA) of £1.25m.

The client was intending to retire in the next few months and was considering their various options for taking pension benefits.

Their Sipp was worth £850,000 and the DB scheme would pay them a pension of approximately £45,000. If they wanted to take a pension commencement lump sum (PCLS) from the DB scheme, this was by commutation, using a factor of 15.

For LTA purposes and presuming they didn’t take any PCLS from the DB scheme, their pension rights were valued at £1.75m ([20 x 45,000] + 850,000).

Prior to the legislation change, one way to try and limit the impact of an LTA charge in these situations was to crystallise the DB rights first and, if the commutation factor was favourable, maximise the PCLS.

Taking no PCLS from the DB rights would use 72% (900,000/1,250,000) of their LTA. Alternatively, if they took a PCLS, the maximum entitlement, presuming the scheme allowed this, would be £207,692 using the commutation factor of 15.

Doing so would leave them with a pension of £31,154. The relevant calculations are shown below.

Their remaining LTA of 33.54% leaves a maximum entitlement to PCLS through the Sipp of £104,812 ([£1,250,000 x 33.54%]/4). Fully crystallising their Sipp would previously have resulted in an LTA charge of £107,693 ([£830,772 + £850,000] – £1,250,000 x 25%) if the excess had been designated to drawdown. This charge falls away as a result of the changes.

If they’d taken no PCLS from the DB scheme, they’d be left with 28% of the LTA and a maximum PCLS from their Sipp of £87,500 ([£1,250,000 x 28%]/4). Again, if they’d designated all to drawdown, there would previously have been an LTA charge of £125,000 (£500,000 x 25%).

Removal of the LTA charge provides the potential opportunity to take a different approach. By taking the maximum PCLS from the Sipp first, this would generate a PCLS of £212,500 with 68% of their LTA used. There’s a smaller residual drawdown fund with this approach, compared to taking the maximum PCLS from the DB scheme.

The remaining PCLS entitlement is £100,000 ([£1,250,000 x 32%]/4) from the DB scheme, with a reduction in the pension of £6,666, leaving £38,334 pension. The latter won’t suffer a further reduction as there’s no LTA charge to pay.

PCLS-wise there’s no difference in the approaches. However, in terms of pension, there’s an increase of £7,180 in index-linked pension by adopting the second approach. Over time, the pension differential will increase, for example, with a 3% rise each year, by year 20 the £31,154 increases to £54,628, while the alternative option increases to £67,218.

Ultimately, which option is best needs to factor in a client’s circumstances. For instance, if they were in poor health with no dependants, then taking the maximum PCLS from the DB scheme might be more appropriate. This potentially leaves a greater amount in their Sipp to pass on to non-dependent individuals.

Either way, some food for thought if you were to come across such a scenario.

Neil MacGillivray is head of technical support at Nucleus