How to Work Out the Maximum Amount of PCLS Available

In this article, we take a look at how to work out the maximum amount of Pension Commencement Lump Sum (PCLS) available at normal pension age under a Defined Benefit (DB) scheme. This is potentially relevant to all CII pension exams, including R04, J05, AF2, and AF7.

There are two ways in which a member of a DB scheme can receive a PCLS at normal pension age:

• by accruing a pension and a PCLS separately; or
• by giving up some of their pension for a PCLS (known as commutation).

The latter is the more usual method, but we’ll examine both as each involves a different calculation when working out the maximum PCLS.

Pension and Separate PCLS

Here the member is entitled to, for example, 1/80^th of their final pensionable salary for each year of service, plus a lump sum of 3/80^th of their final pensionable salary for each year of service.

The maximum PCLS permitted under HMRC rules is 25% of the value of the member’s benefits. Pension benefits are multiplied by 20 and the PCLS is taken at face value. A check is then made to ensure that the PCLS does not exceed 25% of the total benefits taken.

Example

Gloria has just reached her 65^th birthday. She is a member of a DB scheme. Her final pensionable salary is £30,000, and she has 25 years’ service. The scheme’s accrual rate is 1/80^th for pension and 3/80^th for PCLS. The PCLS is given in addition to the pension.

Gloria will therefore be entitled to a pension of £30,000 x 25/80 = £9,375.

Plus, a PCLS of £30,000 x (25×3)/80 = £28,125

To establish the maximum PCLS hasn’t been exceeded, we work out Gloria’s total benefits. Her pension benefits are £9,375 x 20 = £187,500. To this, we add the PCLS of £28,125.

Gloria’s total benefits are therefore £215,625. The PCLS represents around 13% of Gloria’s total pension benefits and is well within the 25% limit.

By commutation

Here, the member gives up some of their accrued pension entitlement in return for their PCLS.

The maximum PCLS is therefore a little trickier to determine, as we need to establish how much pension is left after taking the PCLS. To work this out, we use the following formula:

Where C is the commutation factor used by the scheme.

Example

Eleanor has just reached her 65^th birthday. She is a member of a DB scheme. Her pre-commutation pension is £20,000. The scheme’s commutation factor is 15.

Her maximum PCLS is therefore:

£92,308 (rounded to the nearest pound)

Eleanor’s residual pension will then be:

£20,000 – (£92,308/15) = £13,846 (rounded to the nearest pound).

We can now work out Eleanor’s total benefits. Her pension benefits are £13,846 x 20 = £276,920. To this, we add the PCLS of £92,308.

Eleanor’s total benefits are therefore £369,228. We can double-check that we’ve worked this out correctly as £92,308/£369,228 = 25%.

Alternative formula

Before we bring this blog post to a close, we just want to make you aware that you may come across a different formula during your studies. The one we’ve shown is the CII’s stated preference for R04. However, the one below will give you exactly the same answer for the maximum PCLS from a commutation scheme:

Grab the resources you need!

If you’re studying for your CII R04 exam, and you’re wondering how you’ll ever manage a pass, grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the R04 calculation workbook taster now!

Alternatively, you can download a taster for AF2, AF7 or J05 if you are preparing for either of those exams.

Information in this article is correct as at 30 March 2021.