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HMRC internal manual

Inheritance Tax Manual

Pensions: treatment of alternatively secured pensions from 6 April 2007: unauthorised payments (UP)

There is a potential for income tax charges (excluding Inheritance Tax) of up to 70% where an individual dies whilst drawing income via ASP and

  • the remaining fund is redistributed to other members of the scheme (the scheme is treated as having made an unauthorised payment to the other members) or
  • the remaining funds are paid out of the pension scheme in, most probably, in lump sum form as an unauthorised payment (the lump sum payment is not a charity lump sum death benefit).

The 70% is made up of three elements as follows

  • 40% is accounted for by the unauthorised payments charge.
  • In certain circumstances an unauthorised payment can give rise to an unauthorised payments surcharge. Where it applies, a further 15% of the unauthorised payment is due. A surcharge applies to an unauthorised payment if the surcharge threshold is reached. This will be the case when unauthorised payments in a specified period account for at least 25% of the individual’s pension rights within the scheme. For example if an individual’s rights within a particular pension scheme, valued in accordance with the appropriate legislation, amount to £100,000 and the same individual receives an unauthorised payment of £25,000 from that scheme, the surcharge threshold is reached. The resultant unauthorised payments surcharge would be £3,750 (£25,000 x 0.15). Where there is a re- allocation of funds within the scheme to other members, the 25% test is applied to the receiving member’s funds.
  • If any other unauthorised payment occurs (for example, payment of a lump sum to children who are not scheme members) the reference is to the deceased member’s pot. This is because it is treated as an unauthorised member payment paid in respect of the deceased member (with the tax paid by the recipient . There will always be a surcharge in this scenario as the whole fund is being paid out.
  • The remaining 15% comes from the scheme sanction charge. This charge is levied on the scheme administrator of the pension scheme making the unauthorised payment. A scheme sanction charge is due in respect of a ‘scheme chargeable payment’ and the definition of this payment includes unauthorised payments unless exempt by legislation. The unauthorised payment that will result from the redistribution of ASP funds on death is not exempt and therefore will give rise to a scheme sanction charge (it might be argued the unauthorised payment is exempt if it is made in accordance with a court order but such a set of circumstances is very unlikely). Legislation sets the rate for the scheme sanction charge at 40%, but this is reduced to 15% if all of the unauthorised payments charge has been paid in respect of the scheme chargeable payment.

All this means that, as a minimum, there will be a 55% charge on the amount redistributed made up of the unauthorised payments charge and the scheme sanction charge. The size of the payment, the number of members receiving the redistribution and the value of their respective pension rights will dictate whether any unauthorised payments surcharge(s) applies. Each recipient will suffer an unauthorised payments charge, but not necessarily suffer the surcharge.

Example where re-allocation within the scheme

A small self administered scheme has three members; Andrew dies while drawing benefits via ASP and members Brian and Charles have only uncrystallised rights valued at £500,000 and £900,000 respectively.

On Andrew’s death the remaining ASP fund is £200,000. If all of the ASP fund is redistributed to Brian only, then because the unauthorised payment that is treated as made to him under the tax rules (£200,000 for purpose of this example) is at least 25% of Brian’s pension rights, both an unauthorised payments charge and unauthorised payments surcharge apply, totalling £110,000 55% of the unauthorised payment.

If all of the ASP fund is redistributed to Charles only, then only an unauthorised payments charge applies, totalling £80,000, which is 40% of the unauthorised payment.

If both Brian and Charles each receive £100,000, then no unauthorised payments surcharge is due in respect of either member. The total charge (ignoring the scheme sanction charge) on the ASP fund is £80,000. Brian and Charles are each liable for £40,000.

Regardless of how the fund is distributed a scheme sanction charge of 15% is due accounting for a further £30,000 of the fund (this is assuming that Brian and Charles have each paid all of their respective unauthorised payments charge of £40,000 each).

Therefore the total charge on the redistributed ASP fund ranges from £110,000 (55%) to £140,000 (70%). All of the above assume that neither Brian nor Charles have received any other unauthorised payments.