Across the last couple of weeks, Aries have been asked several questions on the payment of lump sums from registered pension schemes. For this article, I will look at some of these.

Serious Ill Health Lump Sum

This query concerned a case where a Serious Ill Health Lump Sum (SIHLS) was due to be paid to a member who was just about to turn 75.

The question was what would the taxation position be if all of the member’s paperwork etc for the payment of the SIHLS was received before their 75th birthday but the SIHLS was not paid until after that date.

We were able to confirm that the answer here arises under Section 637C of the Income Tax (Earnings and Pensions) Act 2003:

637C Serious ill-health lump sums

(1) Subject to subsections (2) and (4), no liability to income tax arises on a serious ill-health lump sum paid under a registered pension scheme.

…

(4) If a serious ill-health lump sum is paid under a registered pension scheme to a member who (at the time of the payment) is 75 or over, section 579A (pensions) applies to the lump sum as it applies to any pension under a registered pension scheme.

From this, it is the actual date of payment of the SIHLS that dictates the taxation position. In this case, if the SIHLS is not physically paid out before the member’s 75th birthday, then it will be subject to a charge to income tax.

Winding Up Lump Sum

The query in this case concerned the interpretation of Paragraph 10 and Paragraph 12A of Schedule 29 of the Finance Act 2004 in the context of a Winding Up Lump Sum (WULS).

Paragraph 10 here begins as follows:

Winding-up lump sum

10

(1) For the purposes of this Part a lump sum is a winding-up lump sum if—

(a) the pension scheme is an occupational pension scheme,

(b) the pension scheme is being wound-up,

…

(d) it is paid when all or part of the member’s lump sum allowance is available (see paragraph 12A),

The first part of the query was whether this means that the member only needs to have some Lump Sum Allowance (LSA) available in order for the WULS to be paid or whether it means that the member must have sufficient LSA available to cover the entire WULS.

We were able to confirm here that the requirement is simply that the member has some LSA still available – there is no requirement that the  amount of available LSA must cover the entire WULS due.

The second part of the query was , given that the payment of a WULS is not a Relevant Benefit Crystallisation Event (Relevant BCE) for LSA purposes, why does Paragraph 10 above refer to Paragraph 12A at all?

Before answering this, it is important to consider what Paragraph 12A actually says. This paragraph begins as follows:

12A

(1) In this Part of this Schedule, a reference to the amount of an individual’s lump sum allowance that is available on the individual becoming entitled to a lump sum, or being paid a lump sum, is to the amount of that allowance that would be so available on the following assumption.

(2) The assumption is that the individual becoming entitled to or (as the case may be) being paid the lump sum was a relevant benefit crystallisation event within the meaning of section 637Q of ITEPA 2003 (availability of individual’s lump sum allowance).

What this is saying is that, even though the payment of a WULS is not a Relevant BCE, for the purposes of Paragraph 10 (1) (d) above, you must treat the WULS as if it were a Relevant BCE for the purpose of establishing whether or not the member has any LSA still available.

Trivial Commutation Lump Sum

Our third query today concerned the payment of a Trivial Commutation Lump Sum (TCLS) and, in particular, how the benefits being commuted are tested against the £30,000 commutation limit.

In this particular case, the member only had benefits under the defined benefit scheme in question and, under the Scheme Rules, there was no provisions for Late Retirement: if a member retired / took benefits after Normal Retirement Date, the benefits are effectively backdated to the Normal Retirement Date (NRD) with  arrears of scheme pension paid out (as allowed for under The Registered Pension Schemes (Authorised Payments — Arrears of Pension) Regulations 2006 [SI 2006 / 614]).

In this particular case, the member was entitled to a scheme pension of £120 a month, plus arrears of pension from NRD.

The question here was whether and, if so, how, the arrears of pension are taken into account for the purpose of testing against the commutation limit.

We were able to confirm that these arrears are, in fact, ignored, for this purpose. This applies whether the member crystallises the pension before trivially commuting it (in which case the benefits are valued as crystallised rights) or whether the benefits are commuted before crystallisation (in which case they are valued as uncrystallised rights). In either case, the valuation basis here is, in effect:

Relevant Valuation Factor* X the annual rate of pension to which the member is (or would be) entitled to.

(* This will be 20 unless, exceptionally, the scheme has agreed a higher factor with HMRC.)

Any arrears of pension that may be due are not included in the calculation here.

The PTM provides more detail on how to value crystallised and uncrystallised rights for the purpose of the commutation limit.

Aries Insight provides comprehensive and detailed guidance on the application of the lump sum rules under the Finance Act 2004, as well as insight into the meaning and impact of UK pensions regulation and clear guidance on the practical implications for pension providers, trustees, administrators and consultants.  If you are not already an Aries member and would like to find out more about what Aries Insight can offer you, then please drop me a mail at dave@ariesinsight.co.uk or give me a call on 01536 763352.

Please note that we are not lawyers or financial advisers. The information above sets out our best understanding of the legislation and how it applies, but should not be taken as constituting legal or financial advice.