Terence Flanagan (Dublin North East, Independent)
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37. To ask the Minister for Finance in a case where an individual in a private sector defined benefit pension scheme has elected, prior to retirement, to commute a portion into a lump sum, if he will confirm that the age-related valuation factor is only applied to the residual amount of the pension; and if he will make a statement on the matter. [52142/13]

Michael Noonan (Limerick City, Fine Gael)
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I am advised by the Revenue Commissioners that the basis for calculating the capital value of pension rights under the Standard Fund Threshold (SFT) regime is set out in Schedule 23B to the Taxes Consolidation Act 1997. In the case of defined benefit arrangements, the schedule provides a formula for determining the capital value of uncrystallised rights (that is rights being built up but which have not yet been drawn down) with a view to establishing if an individual can apply to Revenue for a Personal Fund Threshold (PFT). Where an individual’s uncrystallised pension rights on the specified date (which for the purposes of the latest revision to the SFT regime, contained in Finance (No.2) Bill 2013, will be 1 January 2014) exceed the new lower SFT of €2m, the individual may claim a PFT from Revenue in order to protect or “grandfather” those rights against any risk of chargeable excess tax when the pension is eventually drawn down. Under the current Finance Bill changes, a PFT may in no case exceed €2.3m, the level of the existing SFT. Schedule 23B also provides a formula for determining the capital value of defined benefit pension rights at the point of retirement.

In establishing the capital value of uncrystallised defined benefit pension rights for PFT purposes, the formula in schedule 23B distinguishes between defined benefit arrangements that provide for a separately accrued lump sum and those that permit a lump sum to be taken by way of a discretionary commutation of part of the pension. In the former case, the capital value is determined by establishing the annual amount of pension that the individual would receive under the rules of the scheme on the specified date (i.e. 1 January 2014) on the assumption that he or she retired on that date at their salary and service on that date and on the assumption that they had attained normal retirement age on that date. The gross annual pension so determined is then multiplied by 20 (the standard valuation factor) and added to the cash value of the separately accrued lump sum, calculated on the same assumptions, to arrive at the overall capital value of the pension rights. In the case of defined benefit arrangements with a discretionary lump sum commutation option, the capital value is determined solely by multiplying the gross annual amount of pension, determined on the same assumptions as above, by the standard valuation factor of 20.

In order for the SFT regime to operate as intended, it is necessary for the capital value of defined benefit pension rights at the point of retirement to be determined in the same manner as the corresponding PFT calculation. In the case of a defined benefit arrangement with an option to commute part of the pension for a lump sum, this means that the capital value at retirement is the annual amount of pension multiplied by the appropriate valuation factors without having regard to any commutation decision that the individual may make.

This ensures that the administrator of a defined benefit scheme, when measuring the capital value of an individual’s retirement benefits from a defined benefit arrangement against, for example, the individual’s PFT, is comparing like with like, as both the capital value of the PFT and the retirement benefits will have been calculated in the same fashion. Only in this way can any chargeable excess arising be correctly determined. The same approach to the calculation of the capital value of defined benefit pension rights at the point of retirement applies where an individual does not have a PFT, as clearly it would be incongruous if the method of calculation in respect of similar defined benefit arrangements were to vary depending on whether an individual had a PFT or not.

It had come to the attention of the Commissioners that pension advisors and administrators had been interpreting the legislation in a manner that allowed the capital value of defined benefit pension arrangements with discretionary lump sum commutation rights to be calculated, at the point of retirement, on the basis of the annual amount of pension, after commutation for a lump sum, multiplied by the relevant valuation factor, plus the cash value of the lump sum so commuted. In light of that, I am putting it beyond doubt, by way of an amendment in Finance (No.2) Bill to the relevant formula in Schedule 23B, that this approach is incorrect and that, in such cases, the capital value calculation must be based on the annual amount of pension that would have been payable if no commutation of the pension had taken place.