What are the retirement options?
The main options a member has on retirement are:
1. A full pension
OR
2. A Pension Commencement Lump Sum (PCLS) PLUS A residual pension
Or, for a scheme that provides flexible benefits
3. Flexible Retirement Options
Regardless of the option chosen, if the benefits, together with all other benefits which the member receives from registered pension schemes, exceed the Lifetime Allowance the member will be subject to a tax charge on the excess.
The standard Lifetime Allowance (LTA) is currently £1,073,100 (2022). In previous years the LTA was higher but there have been a number of pension reforms which have led to the amount being reduced from time to time.
For some members the reduction in the standard LTA would adversely affect the amount of retirement savings that can be taken without incurring an extra tax charge so a member may be protected against this, in which case they will have a certificate from HMRC confirming this.
This section is an overview of the main options. They are discussed in more detail in the Retirement module.
Retirement Options
Defined Benefit Scheme
In a DB scheme, the retirement pension is normally based on:
For example a member has 20 years’ Pensionable Service and the Final Pensionable Salary at Normal Retirement Date is £60,000 per annum. The scheme has an accrual rate of 1/60th for each year of Pensionable Service.
Option 1
The member has the option of receiving a full pension of:(Pensionable Service) x (accrual rate) x (Final Pensionable Salary) = pension20 x 1/60 x £60,000 = £20,000 per annum
Option 2
Part of this pension can be exchanged for a Pension Commencement Lump Sum (PCLS). The maximum amount which is tax free is 25% of the value of the member’s pension based on the formula:(20 x pension) / (3 + (20 / commutation factor))
The commutation factor is different for each scheme depending on the advice from the Scheme Actuary, it is the amount of pension that is given up for each £1 of cash lump sum.
In our example, if the commutation factor was 15, the PCLS would be:(20 x £20,000) / (3 + (20 / 15)) = £92,307.69
The member has to give up part of the pension to receive the PCLS so the residual pension becomes:
£20,000 – (£92,307.69 / 15) = £13,846.15 per annum
The member does not have to take the maximum amount of PCLS offered, they can take a smaller amount if required.
Trivial Commutation
For members of DB schemes, if the benefits available on retirement are small then they may be able to exchange it all for a one-off lump sum. This is known as "trivial commutation lump sum” (TCLS).
Currently, the member must be over age 55 to qualify. The total value of all their benefits across all pension arrangements must be less than a limit set by the government. The current limit is £30,000.
The commutation must take place within a 12 month window and once paid it discharges the scheme from any future liability so for example when the member dies, their spouse cannot make a claim for a spouse’s pension.
Defined Contribution Scheme
In a DC scheme, the pension is based on:
Options available to members of DC schemes depend on whether the scheme allows flexible access.
For those that don’t, the member has the same options as for a DB scheme member i.e. they can chose either a full pension or a PCLS plus a smaller pension, but the calculation is different.
For example, a member has a fund value at retirement of £89,910 and the annuity rate is 14.
Option 1
The member’s full pension would be £89,910 / 14 = £6,422.14 per annum
Option 2
The maximum amount of PCLS the member may take is 25% of their fund.
In our example, it would be: £89,910 x 25% = £22,477.50.
The fund value has now reduced to £67,432.50 so that is the amount used to purchase a pension. The pension would be: £67,432.50 / 14 = £4,816.61 per annum.
The member does not have to take the maximum amount of PCLS offered, they can take a smaller amount if required.
The annuity rate depends on the type of pension the member wants as it is tailored to suit their financial circumstances. For example, a spouse’s pension may be required or a guarantee period. These options are discussed in more detail in the Annuities module.
DC Flexibility
If the scheme rules allow this, a member has the following options from age 55:
Flexi-Access Drawdown (FADD)
A member may not wish to take all of their pension income on retirement, they may be continuing work on a part-time basis or already have sufficient income for a period of time.
At the retirement date the member can take up to 25% of the fund as a PCLS and leave the remainder in a drawdown fund. Further drawdown payments can then be made or the funds can be used to purchase an annuity. FADD gives the member flexibility to receive income when it is needed.
Uncrystallised Funds Pension Lump Sum (UFPLS)
With this option there is no "one” retirement date.
The member can phase receipt of benefits with each withdrawal consisting of 25% tax free cash and 75% is taxed as income. With this option the funds cannot be used to purchase an annuity.Small Pots
For members of DB or DC schemes, if the value of the benefits is very small then they are costly for the scheme to administer and not particularly beneficial to the member so they may have the option of a "Small Pots Lump Sum” payment up to £10,000.
Unlike the trivial commutation payment mentioned earlier, the member’s benefits in other pension arrangements are not taken into account. This option is also available under a personal pension scheme, where the member can have up to three such lump sums under the same scheme.
Retirement Date
For an Occupational Pension Scheme, the Normal Retirement Age for members is stated in the scheme rules, but members are normally allowed to retire earlier if they wish and also possibly to retire later.
Members will normally need to seek consent to retire early.
Defined Benefit Scheme
Early Retirement – The pension will be calculated in the normal way but it will be reduced by an early retirement factor to offset the cost of paying it for longer than anticipated.
Late Retirement – In some schemes the pension contributions must cease at Normal Retirement Age so that no further benefits accrue. A late retirement factor would be applied from Normal Retirement Age until the member does retire so the pension would benefit from some increase. In other schemes members are allowed to continue to contribute and accrue further benefits.
Defined Contribution Scheme
The benefits will always be based on the value of the member’s fund when they actually retire.
Regardless of the scheme benefit basis the member will need to seek consent to retire early.
For personal pension plans (including GPPs) members can take their benefits at any time after they reach age 55 – no consent is required.
Ill-health Retirement
If a member is too ill to work then they may be allowed to retire on ill-health grounds at any age. This will be subject to an independent medical report and not just the opinion of the member’s GP.
Defined Benefit Scheme
Schemes have different terms and conditions, the scheme rules will state how a pension is to be calculated such as:
Defined Contribution Scheme
The pension will be based on the member’s fund at retirement. However, a member may be able to obtain an impaired life annuity which will give them a higher pension.
