General principles: overview of payments
The tax rules split payment into two broad categories:
- member payments - payments made to or in respect of a member or a former member
- Employer payments - payments made to or in respect of a current or former sponsoring employer.
These two broad categories are then subdivided into:
- authorised payments, and
- unauthorised payments.
The tax legislation provides a comprehensive list of authorised payments and the conditions for making each type of authorised payment. Any payment (or deemed payment) a scheme makes that doesn’t fall within the defined list will be classed as an unauthorised payment and taxed accordingly.
Definition of payment
Section 161(2) Finance Act 2004
The definition of ‘payment’ is wide. A payment is not just payment of a monetary amount and the definition also includes:
- a transfer of assets, and
- any other transfer of money’s worth.
Payment to a connected person
Section 161(5) to (7) Finance Act 2004
A payment can be made to a person who is not a current or former member, or a current or former sponsoring employer but still be treated for tax purposes as a payment to a current or former member, or a current or former sponsoring employer (as the case may be). This will happen if the person receiving the payment is connected with:
- a member
- a former member
- a sponsoring employer
- a former sponsoring employer, or
- was connected with a member or former member on the date of the death of the member or former member.
In this case the payment will be treated as made to the member, the former member, the sponsoring employer, or the former sponsoring employer to whom the person receiving the payment was connected.
Where a scheme enters into a transaction that increases the value of an asset or decreases the amount of a liability (value shifting), of a person connected with
- a member
- a former member
- a sponsoring employer
- a former sponsoring employer, or
- was connected with a member, or former member on the date of the death of the member or former member.
the increase in the value of the asset, or decrease in liability will be treated as for the benefit of the member, the former member, the sponsoring employer, or the former sponsoring employer (as the case may be). Further information on payments and value shifting can be found at PTM133700.
PTM027000 sets out further information on connected persons and what is meant by ‘connected with’.
Investments and annuity or insurance contracts
Section 161(3) and (4) Finance Act 2004
The legislation treats payments made (or benefits provided) under or in connection with any annuity or insurance contract (or other investment vehicle) purchased using sums or assets held by a registered pension scheme, as payments under the originating scheme.
Where the purchased item (annuity, insurance contract, investment vehicle etc.) remains in the ownership of the scheme, then the payment is already considered a payment under the registered pension scheme under section 161(2) Finance Act 2004.
Section 161(3) and (4) Finance Act 2004 come to the fore when the scheme does not own the purchased item. Typically, this may arise where a scheme buys an annuity policy from an insurance company ‘in the member’s name’. Here, the member owns the policy (rather than the scheme) and the insurance company is directly liable to the member.
So, for example, where a lifetime annuity is purchased from a money purchase arrangement any payment made by that contract on the death of the annuitant should comply with the authorised pension death benefit rules and lump sum death benefit rule (see PTM070000). If the contract provides an unauthorised member payment the payment will be taxed accordingly (see PTM134000).
Where a scheme is wound-up
Section 161(4) Finance Act 2004
A payment or benefit from an investment or annuity contract purchased by a registered pension scheme is still treated as paid from assets or sums held for the purposes of that scheme where that scheme has wound-up since its purchase. So the investment/contract is still bound by the authorised and unauthorised member payment rules.
Authorised member payments
Sections 160(1) and (2) and 164 Finance Act 2004
Sections 164 to s168 Finance Act 2004
Registered pension schemes are only authorised to pay out benefits to or in respect of a member in two forms, either as a pension and/or a lump sum.
The legislation lists all the authorised forms of pensions and lump sum payments, the circumstances in which they can be paid, and sets out the conditions and restrictions that these payments or entitlements must meet or follow in order for them to be authorised. The legislation refers to these rules as
- “the pension rules”
- “the lump sum rule”
- “the pension death benefit rules”, and
- “the lump sum death benefit rule”.
If a benefit payment (or part of it) does not meet all of the conditions and restrictions of the relevant rules it will be an unauthorised member payment and will be taxed accordingly (unless it meets the conditions of any of the other authorised member payments).
The sort of benefits most likely to be made to or in respect of a member of a registered pension scheme that are authorised payments will be:
pensions paid to the members - typically when the member retires, see PTM062000. These could be:
- purchase of an annuity to provide regular retirement income
- scheme pension (similar to an annuity but paid directly from the scheme’s funds)
- drawdown fund (money left in the scheme to be taken as and when the member chooses)
- lump sums paid to the members - often at the same time as the member takes the pension see PTM063000,
- pensions paid to beneficiaries of deceased members - see PTM072000, and
- lump sums paid on the death of a member - see PTM073000.
Broadly, all pensions in a member’s lifetime will be subject to income tax. For most authorised lump sums paid to members, up to a maximum of 25 per cent of the value of the pension pot will not ordinarily be subject to tax, though for some lump sums this tax-free element is 25 per cent of the lump sum itself. Whether or not payments on the death of a member will be subject to income tax will depend on the type of payments and when they are paid.
Additional income tax charges will apply when pensions or lump sums are paid to or in respect of a member when that member’s lifetime allowance is used up - see PTM081000.
Where the individual’s lifetime allowance has been fully used up, any unused funds or entitlements the member holds in a registered pension scheme may be paid wholly as a taxable lump sum, called a lifetime allowance excess lump sum. The lifetime allowance charge arising on the resulting chargeable amount will be higher where a lifetime allowance excess lump sum is paid - see PTM083000.
There are also circumstances where pension benefits may be fully commuted and paid wholly as a lump sum (such as serious ill-health or triviality). The different types of authorised lump sum payments are dealt with at PTM063000.
Other authorised member payments
Sections 164, 169 and 171 Finance Act 2004
The following are not payments of benefits, but are also authorised member payments:
- a transfer payment from one registered pension scheme to another, or to a qualifying recognised overseas pension scheme (what is referred to in the legislation as a recognised transfer),
- a scheme administration member payment, or
- payments related to a pension sharing order.
Unauthorised member payments
Sections 160(2) and 172 to 174A Finance Act 2004
Any payment made to, or in respect of, the member that does not fall within the list of authorised member payments is an unauthorised member payment.
These include for example (not exclusively):
- most lump sums paid to a member before normal retirement age, except, for example, on ill-health
- transfers to a pension scheme that is neither a registered pension scheme nor a qualifying recognised overseas pension scheme
- loans to members.
Other situations may be treated as ‘deemed’ unauthorised payments, such as recycling of pension commencement lump sums - PTM133800.
More detailed information on unauthorised payments, including tax charges can be found at PTM130000.
Payments to a sponsoring employer of an occupational pension scheme
Sections 150(5), 160, 161 and 175 to 181 Finance Act 2004
In general terms, a sponsoring employer is an employer who sets up or arranges for an occupational pension scheme to provide benefits for their employees - see PTM022000.
The legislation deals with payments made by a registered pension scheme that is an occupational pension scheme to (or in respect of) a sponsoring employer in exactly the same way as with member payments.
There is a definitive list of authorised employer payments and the characteristics a payment must exhibit in order to meet such definitions - usually they must be transactions at arms-length value. Any payment to (or in respect of) an employer that does not fall within any of these definitions is an unauthorised employer payment and is taxed accordingly. There are also similar rules on connected transactions and value shifting.
Payments to employers and their taxation are covered in more detail in PTM145000.
Where a payment is made to or in respect of an employer who is not a sponsoring employer of the scheme concerned, the payment will fall to be treated as an authorised or unauthorised member payment, depending on the circumstances.