The subject of commutation has been gathering speed over the past few months, so here it is at No. 3
Q: What are the different types of commutation and how do they apply to my pension schemes?
A: Put simply, commutation is the replacement of one type of benefit with another. Commutation may take the form of giving up pension income in exchange for an increased lump sum or giving up all or part of a lump sum to generate additional income. Each pension scheme has different options and rules around age, career point and maximum amounts that can be commuted.
Resettlement Commutation (AFPS 75 only):Resettlement Commutation (AFPS 75 only):Resettlement Commutation is a specific term relating to commutation under the ‘75 scheme. Under the scheme rules, those leaving with an Immediate Pension (IP) having given 22 years Reckonable Service (RS) from age 18 as an Other Rank or 16 years RS from age 21 as an Officer, may commute pension income to generate a larger lump sum. This is ‘repaid’ from their pre-tax pension between their retirement and age 55. This can be tax efficient, as it reduces an individual’s level of earned income. The amount you may commute reduces the closer you are to age 55. At age 55, your pension income is restored to its pre-commutation levels; you may not commute your ‘75 pension if you leave after the age of 55.
Inverse Commutation (AFPS 05 and 15 only):Inverse commutation is available under AFPS 05 and 15 only. AFPS 05 provides a tax free lump sum which is payable on discharge at or after age 55, or at age 65 if discharged before age 55. When payable, individuals may choose to give up some or all of this lump sum to improve their taxable pension. This is known as Inverse Commutation and may increase an individual’s tax bill as it increases their earned income. AFPS 05 also provides an automatic tax-free Early Departure Payment (EDP) lump sum normally worth three times the pension. To qualify, individuals must have given at least 18 years’ service and must be at least age 40. There are no commutation options in respect of this lump sum. AFPS 15 provides an automatic tax-free EDP lump sum of 2.25 times pension. To qualify, individuals must have given at least 20 years’ service and must be at least age 40. The whole EDP lump sum, all or nothing, can be surrendered to improve their EDP income, which may increase tax liability by increasing ‘earned income.
Commutation (AFPS 15): AFPS 15 does not provide an automatic pension lump sum. The pension is payable on discharge if aged 60 or older, or at State Pension Age if discharged before age 60. When it is payable, an individual may choose to generate a tax-free lump sum by surrendering some of their pension. This pension reduction remains in place for life and is never restored. Commutation may have the effect of reducing tax liability as it reduces earned income.