As your discharge from the Armed Forces approaches many of you will have choices to make about lump sums and it is important that you understand them.
These lump sums and their irrevocable options are as follows:
- AFPS 75 provides an automatic tax-free lump sum of three times the pension. Those leaving with an Immediate Pension (IP) having given 22 years Reckonable Service (RS) after age 18 as an Other Rank or 16 years RS after age 21 as an Officer can choose to buy another lump sum and pay for it from their pre-tax pension between their retirement and age 55. This is known as Resettlement Commutation and can be tax-efficient as it reduces ‘earned income’. This is not available to those leaving with an invaliding pension.
- AFPS 05 provides an automatic tax-free lump sum of three times the pension. It is payable on discharge with an ill-health pension, discharge at or after age 55 or age 65 if discharged before age 55 and, when payable, individuals may choose to give up some or all of this lump sum to improve their taxable pension. Surrendering some or all of a lump sum to increase income is known as inverse commutation (IC). IC may increase the member’s tax bill as it increases ‘earned income’.
- The AFPS 05 EDP scheme provides an automatic tax-free lump sum normally worth three times the pension to those who have given at least 18 years service and are at least age 40 on discharge. There are no options in respect of this lump sum.
- AFPS 15 does not provide an automatic pension lump sum. The pension is payable on discharge with an ill-health pension, on discharge on or after age 60 or at state pension age, if discharged before age 60 and, when it is payable, any member can commute – that is they may generate a tax-free lump sum by surrendering pension. Commutation has the effect of reducing tax liability as it reduces ‘earned income’.
- The AFPS 15 EDP scheme provides an automatic tax-free lump sum of 2.25 times pension to those who have given at least 20 years service and are at least age 40 on discharge. The EDP lump sum – all or nothing – can be surrendered to improve their EDP income which may increase tax liability by increasing ‘earned income’.
Currently, most of you have entitlements in more than one scheme, having been transferred to AFPS 15. You are probably aware that MOD are working on a remedy to address the age discrimination contained it in transitional arrangements for transfers to AFPS 15 but, until we know what the MOD plan to do … and discharges continue in the meantime … the following example is based on the situation at time of writing.
A Sergeant joined on 1 April 1998 and was discharged on 31 March 2020 at age 40 (exactly 22 years service). Their final pensionable pay (FPP) is £40,000 and AFPS 15 pension is £4,198.44.
Their AFPS 15 benefits and choices would be:
When they comes to claim this pension they can choose to commute to generate a lump sum – rule of thumb: £1 surrendered generates £12 tax-free. Their pension is going to increase in line with Consumer Price Index (CPI) inflation between their discharge and the date at which they claim but, for the purposes of this example, we are using the current value to illustrate AFPS 15 commutation. To calculate the maximum lump sum they can generate:
Multiply the pension by 20 and divide by 56 = £1,499.44
Multiply £1,499.44 by 12= £17,993.28
The pension remaining would be (£4,198.44 - £1,499.44) £2,699.
An AFPS 15 EDP tax-free lump sum of £9,446.49(2.25 x pension) and an annual EDP income of £1,427.47 (34% of pension) payable until state pension age, with CPI increases applied at age 55. If he gave up the EDP tax-free lump sum his taxable EDP income would increase by £512.94 per year.
Had they been an AFPS 05 member before 1 April 2015, they would be entitled to the following:
AFPS 05 pension and lump sum, preserved until age 65. The pension would be FPP x RS in AFPS 05, divided by 70 (£40,000 x 17/70 = £ 9,714.29). The tax-free lump sum would be £29,142.87. For each £100 of the tax-free lump sum they give up, their taxable pension will improve by £6.10 per year so, if they surrendered the whole of their tax-free pension lump sum their taxable pension would increase by £1,768.97
An AFPS 05 EDP tax-free lump sum of £29,142.87 and an annual EDP income of 50% of the value of the AFPS 05 pension, rising to 75% at age 55 plus CPI increases. They have no choice to make in respect of their EDP lump sum.
Had they been an AFPS 75 member prior to 1 April 2015, they would be entitled to the following:
An AFPS 75 IP of £8,997.64, which is 17/22nds of the 22 year rate for a Sergeant*. The tax-free lump sum is £26,992.92. The most they can commute is the difference between the 22 year lump sum for a Sergeant (£34,932) and the lump sum for a Sergeant with 37 years service (£53,220) – so £18,288. So, if they took the whole £18,288, his pre-tax pension would be reduced by £1,717.61 per year(£93.92 per £1,000) until age 55 when his pension will be restored to its original level and increased by CPI.
*Based on 2019/20 Pension Codes as 2020/21 Pension Codes are not yet available.
If you are a member of the Forces Pension Society and have questions about lump sum choices or any other pension related issue, contact email@example.com.
If you are not a member but would like to join, you can do so here
Author Mary Petley, and written for the Summer issue of Easy Resettlement