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HMRC internal manual

PAYE Manual

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HM Revenue & Customs
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Reconcile individual: end of year reconciliation: small pension taken as a lump sum payment (formerly known as trivial commutation payments)

For Pension Flexibility refer to PAYE94055

This subject is presented as follows

Background

Registered pension schemes and life insurance companies can pay small lump sums (formerly known as trivial commutation payments). This means that a single lump sum is paid to the recipient instead of a continuing small annuity or pension.

The usual PAYE procedures may result in the customer paying too much tax on the date the payment is made, even when over the full year only basic rate tax is due. This is because of the way in which the tax tables work. You should be aware that the customer may make a repayment claim.

Instructions on how to deal with a claim to repayment are given in ‘Small pension taken as a lump sum payment (formerly known as trivial commutation payments)’ action guide tax40104.

Up until April 2006 there were different tax rules for such payments, depending on the type of pension scheme making the payment. Small lump sum payments paid by occupational pension schemes were not taxable income of the recipient but triggered a tax charge on the scheme administrator, whereas similar payments from personal pension schemes were treated as taxable income of the recipient and PAYE was applied. The payer could have operated PAYE by applying an emergency code, or a code had been previously issued.

The legislation has changed so that from April 2006 all small lump sum payments are taxable pension income of the recipient and the pension payers must apply PAYE. This applies to all pension schemes and also to life insurance companies and other bodies that commute annuities, where the annuity is in respect of a former pension scheme.

The pension provider / annuity payers will provide P45 details in these circumstances.

As these payments are PAYE income, the payer will apply PAYE in the usual way. A pension or annuity can be commuted either

  • Before the pension / annuity starts to be paid

Or

  • After payment has already commenced

Before the pension / annuity comes into payment

As the pension / annuity has not yet come into payment, the pension / annuity payer will not have a tax code to tax the commutation payment. The usual PAYE procedures will apply, and the payer will use the Basic Rate code on a non cumulative basis. Form P45 will be issued showing the small lump sum payment and the relevant date that the payment was made as the date of leaving.

Up to twenty five per cent of the small lump sum payments in respect of a pension / annuity that has not yet come into payment are exempt from tax. The payer will only enter the taxable portion of the payment on documentation for HMRC. The full amounts shown on forms P45 / P14 should therefore be used in any calculations.

After the pension / annuity has started to be paid

As the pension / annuity has already started to be paid, the payer will already have a tax code in use to tax the small lump sum payment. Form P45 will then be completed showing both the small lump sum and any other payments made during the tax year, the total tax deducted together with the relevant date the payment was made as the date of leaving.

All of the small lump sum payments in respect of a pension / annuity that have already started to be paid are taxable income.

After end of year

With effect from 6 April 2013 there is no longer any need to issue an End of Year P53 review form. All cases will now be reviewed by the auto reconciliation process.

Note: You must be aware that receipt of forms P45 for pension / annuity references does not always mean that the taxpayer has died.