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HMRC internal manual

Employment Income Manual

Social security pension lump sum: charge to income tax

Section 7 Finance (No2) Act 2005

Section 1(1)(b)(ii) ICTA 1988

Section 835 ICTA 1988

Section 577(1A) ITEPA 2003

See EIM74650 for an overview of the state pension lump sum option introduced from 6 April 2005.

Section 7(1) Finance (No2) Act 2005 confirms that a charge to Income Tax arises when a person becomes entitled to a state pension lump sum. But section 7(2)(b) advises that any state pension lump sum shall not be taken into account when determining the person’s total income.

These rules mean that whilst any state pension lump sum is charged to Income Tax it will not be aggregated with the individual’s other income and consequently it cannot push the individual into a higher tax band. Neither can it affect the amount of any age-related personal allowance or married couple’s allowance that might be due.

Instead any state pension lump sum is taxed at the highest rate of tax that applies on the individual’s total income. This highest rate is the one that applies after the set-off of all reliefs and allowances that are deducted in ‘arriving at’ and ‘from’ total income. This rate of tax is commonly referred to as the individual’s “marginal rate”.

This approach was confirmed during the committee stage of the Finance Bill debate “ Total income is a statutory expression that draws together all sources of income that are taxable and from which certain deductions, including personal allowances, are then available. That net amount of income is then charged to income tax at the appropriate rates. I am happy to confirm that the rate of tax applied to the lump sum, commonly known as the marginal rate, is the one that applies to total income less all statutory deductions and personal allowances that can be deducted. “ (Hansard- Standing Committee B, 21 June 2005 AM, Column 25, Ivan Lewis, Economic Secretary to the Treasury)

For example if the individual is liable to income tax in a tax year at the basic rate on their other income, that rate will also apply to any state pension lump sum.

Social security pension lump sum

The legislation uses the term “social security pension lump sum”. Section 9(1) Finance (No.2) Act 2005 explains that “social security pension lump sum” means

(a) a state pension lump sum,

(b) a shared additional pension lump sum, or

(c) a graduated retirement benefit lump sum.

Most social security pension lump sum payments are expected to be in respect of a state pension lump sum. For convenience, therefore, this guidance uses the term “state pension lump sum” but this should be read as including a shared additional pension lump sum and a graduated retirement benefit lump sum.