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HMRC internal manual

PAYE Manual

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HM Revenue & Customs
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Reconcile individual: in-year reconciliation: state pension deferral lump sum payments

This subject tells you about the provisions for deferring receipt of state pension, from April 2005 to March 2016, and how those changes affect PAYE work.  See guidance included within action guide ‘Deceased Return Capture’ available on the Personal Tax Operations Guidance Gateway.

The rest of this subject is presented as follows

Background
Taxation of lump sum payments from Department of Work and Pensions (DWP)
Choosing when to receive the deferred lump sum payment
Dealing with enquiries
State pension deferral and death
What DWP does
When mistakes occur
What DWP provides to HMRC
Claiming repayments

Background

For many years, anyone meeting the requirements for receiving the state pension has been able to defer receipt of that pension by not submitting a claim for it. Anyone deferring their pension is compensated for the amount foregone by receiving enhanced weekly pension payments when they do eventually submit a claim.

The rules however changed with effect from 6 April 2005 as part of the Governments aim to provide flexibility and choice after reaching retirement age.

Anyone already deferring their claim at 5 April 2005 or beginning a period of deferral from 6 April 2005 (or, if later, the date on which deferral began) extends for less than 12 months, then the pensioner will receive an increased weekly rate of state pension. This is little changed from the previous position.

This change affects PAYE where the period of deferral from 6 April 2005 and 5 April 2016 extends for more than 12 months.  When this happens the pensioner can choose to receive either

  • An increased weekly amount of state pension
    Or
  • A one off lump sum, and the weekly state pension paid at the standard rate

Anyone receiving the new state pension from 6 April 2016 will not be able to receive a lump sum. They will only be able to receive the increased weekly rate if they defer their pension for 9 weeks or more.

There is no change to the way in which weekly state pension is charged to tax and further details can be found in PAYE76001.

Legislation ensures that a one-off lump sum payment is chargeable to income tax. As each lump sum payment will be a significant amount, the legislation allows for the lump sum to be taxed in a different way to the weekly state pension.

Note: DWP will not deduct tax at the Scottish rates. Scottish customers will either under or overpay tax in the years that the rates differ.

A separate scheme has been set up for DWP to remit tax, and this scheme is dealt with by Leicester and Northants area. (This content has been withheld because of exemptions in the Freedom of Information Act 2000) DWP submit forms P35 and P14 at the end of each tax year, and make monthly payments on PAYE, but a separate notification of the award is issued rather than a P60.

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Taxation of lump sum payments from Department of Work and Pensions (DWP)

The amounts that are paid as stated above are taxable only at the marginal rate and are subject to PAYE deductions. This means that the whole of the lump sum is taxed at the highest rate of tax at which the pensioner is otherwise liable (excluding this payment and any amounts that extend the basic rate band). For this purpose only, savings and dividend income is treated in the same way as any other income and the special tax rates applying to those sources of income are disregarded. The lump sum payment should not be taken into account when calculating Net Statutory Income, age-related allowances and so on. Tax is deducted by DWP, using a modified form of PAYE, so the pensioner receives the net amount.

For example, if a pensioner is otherwise liable to tax at the basic rate, then the full amount of the state pension deferral lump sum payment is also taxable at the basic rate, irrespective of the size of the payment. If the pensioner is liable to tax at the higher rate but the basic rate band is extended to cover all the income, the lump sum is taxed at the higher rate. If the pensioner is not liable to pay income tax then they can declare that no tax should be withheld by DWP when they make the payment. After the end of the tax year we will check the tax withheld and repay any tax over-deducted or ask for the balance if too little was withheld.

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Choosing when to receive the deferred lump sum payment

The state pension lump sum is assessable on the basis of entitlement. A pensioner is entitled to the lump sum on the first day from which payment of the weekly state pension should begin (regardless of when payment does in fact start or when the lump sum is paid). There is however one exception to this as follows

A pensioner can choose whether to receive the lump sum payment either

  • In the year in which they claim the state pension
    Or
  • In the following tax year

If a pensioner elects to receive the lump sum in the later year, then the lump sum is assessable in that later year.

Pensioners may choose the later year where they have deferred state pension while they carried on working. They may anticipate that their marginal rate in the year in which they retire and begin to receive their weekly state pension will be greater than it will be in the following year. For example, they may be liable at the higher rate in the year of retirement, when they start to receive state pension, but only liable at the basic rate in the following year. In such circumstances it could be beneficial to them to receive payment of the deferred lump sum in the year following the year of retirement.

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Dealing with enquiries

You may receive queries from pensioners requesting assistance in working out their likely marginal rate, perhaps in order to help them make a decision as to when to choose to receive the lump sum.

When you give advice about the marginal rate you must stress that

  • You can only provide assistance on the basis of the information that you have been given
  • That any guidance you can give will only be provisional
  • The actual amount of income received in a year - and the rate at which that income is taxable - cannot be finalised until after the end of the tax year

You must take care

  • Not to advise pensioners specifically in which year they should claim the lump sum payment
    And
  • To restrict your advice to helping to calculate the marginal rate of tax

You can use the calculators available from the Excel SEES package to help you estimate tax liability excluding payment of the lump sum.

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State pension deferral and death

When a pensioner has notified DWP that a period of deferral is to cease on a specific date and dies after that date but before DWP make payment, then the lump sum will form part of the estate, being income that the deceased was entitled to prior to death. The weekly amount of state pension for the same period would also be treated as part of the estate as it is only administrative processes that have prevented payment.

Where a pensioner dies during a period of deferral any accrued entitlement to either a lump sum or enhanced state pension payments passes to any surviving spouse or civil partner. However, the spouse or civil partner can only claim the deferred pension if they are already of pension age. If they are under pension age then only a widow may inherit, but only

  • On reaching pension age
    And
  • Claiming her own state pension
    And
  • Provided that she does not remarry before that date

This is in addition to any state pension or state pension deferred lump sum payment that may be due to them in their own right.

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{#whatdwpdoes}What DWP does

When DWP make these payments they withhold tax at either

  • The pensioner’s declared marginal rate
  • Or
  • The basic rate, in the absence of a declaration
    And
  • At rest of UK tax rates

Declarations are made on a form that DWP send to the pensioner but they can also be made and accepted over the telephone.

Once DWP receive a declaration they calculate the tax to be withheld from the payment at the rate given on the declaration. If the declaration has not been received by the payment date then tax will be withheld at the basic rate.

The net lump sum payment is made to the pensioner and DWP provide the pensioner with notification of the amount received and tax deducted. The notification is issued when the payment is made, not at the end of the year. DWP do not issue form P60 at the end of the year.

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When mistakes occur

Mistakes should be extremely rare as the DWP system includes a series of checks to be carried out before payment. These checks should identify and correct most inadvertent errors.

If DWP incorrectly deduct tax at a higher rate than the rate notified to them they will normally, where appropriate to do so, adjust the position during the year.

If a pensioner contacts HMRC saying that they have advised DWP of the incorrect rate, you should explain that they will need to contact DWP to see if they are able to revise the position in-year. HMRC are unable to review the situation before the end of the tax year when full income details for the year are known.

Where insufficient tax has been deducted because tax was withheld at a lower rate than the pensioner had declared to DWP, HMRC will seek to collect the correct amount of tax from the pensioner.

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What DWP provides to HMRC

When DWP makes a lump sum payment they will provide details on form P46(LS) to the Leicester office in every case. If a pensioner is to receive more than one lump sum payment during a year, one in their own right and one from a deceased spouse or civil partner, then only one form P46(LS) will be issued and only one form P14 received at the end of the year.

When a pensioner changes their mind and chooses to receive additional state pension instead, they must tell DWP within 3 months of making their original decision.

If the pensioner changes their mind within the same tax year that they received their lump sum, then DWP will

  • Submit their P35 at the year end with a nil P14 for each pensioner that changed their mind during the year. DWP must enter a cessation date of 5 April on each P14
  • DWP can claim their refund by reducing their monthly payments to HMRC up to 5 April of that year
  • At the year end if there are any monies that have not been self served, HMRC will make a refund to DWP once the P35 and forms P14 have been successfully processed

If the pensioner changes their mind after the tax year in which they received their lump sum and the P35 and forms P14 have already been submitted, then DWP will

  • For each month where this applies, submit an amended P35 and forms P14 for the pensioner to reduce their pay and tax to zero
  • HMRC will then refund any overpaid monies to DWP once the amended return has been successfully processed

If the pensioner dies before the payment can be made, then DWP will make the payment to the estate of the deceased and will notify Leicester of the death.

Where a pensioner chooses to receive the lump sum in the same year in which they start to claim their weekly state pension, DWP may not be able to until after the P35 and P14 information for that year has been submitted. For those cases DWP will submit an amended return.

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Claiming repayments

When pensioners claim an in-year repayment they should be asked to complete form P50.  In addition to any pay and tax details from their P45 , you should ask pensioners to provide the notification from DWP about their lump sum payment.

When a pensioner has died, this income should also be declared and again the notification from DWP requested so that the automatic In year reconciliation following death can take place accurately.

Where the tax due at the marginal rate is less than the tax shown on the DWP notification the balance can be repaid in the usual way. The DWP notification should be date stamped and returned to the pensioner, in the same way that a P60 would be treated.

The end of the year return will be made in the usual way.

Where in-year repayments are made, the calculations will include an estimate of income from all open employment(s)/pension(s). The computation issued to the pensioner must include the state pension deferred lump sum amount at the pensioner’s marginal rate of tax. It is important that these calculations are accurate as it is possible that the rate at which tax has been withheld may be higher than the true marginal rate in these cases.