This guide is for financial advisers only. It must not be distributed to, or relied on by, customers. The information in the guide is based on our understanding of legislation at November 2024.
One of the main benefits which most registered pension schemes can pay to members is a tax-free lump sum. In this guide, we cover the main rules for paying this benefit.
In this guide, ‘LSA’ means ‘Lump Sum Allowance’ and ‘LSDBA’ means ‘Lump Sum and Death Benefit Allowance'.
PCLS entitlement
Payment of a PCLS must always, with one exception, be related to the payment of a 'pension benefit' under the pension scheme, for example:
- a scheme pension
- a lifetime annuity
- designation into drawdown
If a lump sum is paid without a related crystallisation of pension benefits it is not considered a PCLS and won't be tax-free. The exception to this rule is when the member is entitled to a scheme-specific protected PCLS and the remaining fund is small enough to be taken as a trivial lump sum.
In addition to the requirement that a pension benefit must be crystallising, there must be sufficient LSA and LSDBA available for a PCLS to be paid.
Period of entitlement
The lump sum must be paid within an 18-month period starting six months before and ending 12 months after the member becomes entitled to it. Entitlement to the PCLS arises on the day that actual entitlement (as opposed to prospective entitlement) to the linked relevant pension arises.
Maximum PCLS
The maximum PCLS (tax-free cash), also known as the 'permitted maximum', that is normally available from a registered pension scheme is the lesser of:
- 25% of the value of the pension benefits, also known as the 'applicable amount', and
- 25% of the member's remaining LSA and LSDBA.
Tax-free cash can be higher (or lower) than this where:
- the member has tax-free cash protection (also known as scheme specific tax-free cash protection)
- the total value of an individual’s crystallised and uncrystallised lump sum rights on 5 April 2006 was more than £375,000 and that individual had registered their tax-free cash entitlement along with their enhanced and/or primary protection
- where some or all of an individual’s fund comes from a disqualifying pension credit. No tax-free cash is allowed from the portion in respect of a disqualifying pension credit.
Restricting PCLS
If the available PCLS (based on the applicable amount) has to be restricted to the available LSA and LSDBA it might be possible to pay the remaining PCLS (up to the applicable amount) as a Pension Commencement Excess Lump Sum (PCELS), previously known as the lifetime allowance excess lump sum - refer to the section below.
If a member has used up all of their LSA or all of their LSDBA and they are still entitled to further pension benefit, the benefit may be commuted and paid as a lump sum. This payment is now known as the Pension Commencement Excess Lump Sum (PCELS). Before the abolition of the lifetime allowance, the equivalent benefit was a 'lifetime allowance excess lump sum'. If a scheme's rules allowed the payment of a lifetime allowance excess lump sum, they can be read as allowing the payment of a PCELS.
The legislation allows for this lump sum payment but pension schemes are not obliged to offer this feature within their scheme rules. It does not limit the payment of the PCELS to particular arrangements but the payment cannot otherwise be an 'excluded lump sum' payment as defined in the legislation.
What is an excluded lump sum
A lump sum is an excluded lump sum if it would be permitted under the 'lump sum rule' in section 166 of the Finance Act 2004. The lump sum rule includes, for example, uncrystallised funds pension lump sums (UFPLS) and serious ill-health lump sums. A scheme cannot pay a PCELS if it would be possible for them to make one of the payments allowed for under the lump sum rule. Note that this applies even if the rules of the scheme in question do not allow such a payment.
In practice, this requirement is most likely to affect defined contribution schemes which do not offer UFPLS payments. Because the legislation allows defined contribution schemes to make an UFPLS payment, such a scheme will be prevented from paying a PCELS even if their governing rules do not allow for the payment of an UFPLS.
Conditions for a PCELS
For those arrangements that can offer the PCELS, the following conditions must first be met:
· A PCELS can only be paid if the LSA or LSDBA has been fully used up.
· the member becomes entitled to it in connection with becoming entitled to a relevant pension
· it is paid within the period beginning six months before, and ending 12 months after, the day on which the member becomes entitled to it
· it does not reduce the rate of payment of any pension to which the member has become (actually) entitled, or extinguish the member's entitlement to payment of any such pension
· it is paid when the member has reached normal minimum pension age or the ill-health condition is met
· it is not an excluded lump sum
In practice we expect only occupational schemes to offer this option when paying benefits which exceed the LSA or LSDBA.
All payments of PCELS will be taxed at the recipient's marginal rate.
Further information
You can find more information on the PCLS and the PCELS in HMRC's Pensions Tax Manual: