PTM061310 - Member benefits: essential principles: what is meant by 'becoming entitled' to pensions and lump sums
Glossary |
What is meant by 'becoming entitled' to a lump sum
Section 165(3) Finance Act 2004
A member with the expectation of receiving pension payments at some time in the future is said to have a ‘prospective right’ to pension. For the purposes of the legislation, the member only becomes ‘entitled’ to a pension benefit at the point when they first obtain an ‘actual right’ to receive it. This ‘actual right’ has to be distinguished from their ‘prospective right’. An ‘actual right’ is when a member has the right to a benefit without having to fulfil any further conditions or take any further actions, for example:
having to agree to or authorise the payment of a benefit or
having to obtain an employer’s or scheme trustee/scheme administrator’s agreement or co-operation to benefit payment.
Although the term ‘actual right’ refers to the receipt of real benefit, rather than merely being in possession of a right to obtain it, it does not necessarily refer to the date a benefit is actually paid out.
Entitlement to drawdown pension specifically arises whenever all or part of the sums and assets within a money purchase arrangement, that is not a collective money purchase arrangement, are designated to be available to pay a drawdown pension. See example 5 below.
Determining the point at which entitlement to a scheme pension or lifetime annuity actually arises can call for a more careful application of the principles explained above. Examples 1 to 5 show how this works in more detail.
Example 1
Michael’s pension scheme rules state that pension benefits will come into payment on the member’s 65th birthday. This should happen automatically as Michael has notified the scheme of the option he wishes to exercise and has confirmed all the necessary information, for example bank details, to put the pension into payment. Michael is 65 on 15 September but his scheme experiences internal administrative delays and does not pay him any benefits until 1 October that year, but Michael still has an actual right to the payment of benefits on his 65th birthday, so his benefit entitlement arises on 15 September, not the actual benefit payment date of 1 October.
Example 2
The rules of Asif’s pension scheme state that a member may receive benefits from age 55 onwards and that benefits must come into payment by age 75. Asif is 57. Although Asif is eligible to take benefits from the scheme he has not yet opted to take benefits. So, his right to benefits is prospective, not actual. He does not yet have any benefit entitlement.
Example 3
This is a variation on example 1.
The rules of Yvette’s pension scheme state that pension benefits will come into payment on the member’s 60th birthday. According to scheme records, Yvette’s 60th birthday is on the 13 December 2013, so 6 months before that date, the scheme administrator writes to her last known address to ask what account she wants the benefits paid into. However, there is no reply and the scheme is not able to contact Yvette to finalise the formalities. They are unable to make the payment on Yvette’s birthday in December. It is another year before they are able to trace her and details of the bank account to pay into are not confirmed to them until the 5 January 2015. Under the benefit rules of the scheme, Yvette’s benefits accrued to the 13 December 2013 and were due to be paid from that date, but by virtue of the matter-of-fact delay, Yvette’s entitlement remained a prospective one. Yvette has only become ‘actually entitled’ to the benefit for the purposes of the tax rules, on the 5 January 2015. Under the rules of the scheme, the scheme also must pay arrears of pension for the period between the ‘potential entitlement’ on 13 December 2013 and the date of ‘actual entitlement’ on 5 January 2015. This is permitted under SI 2006/614 for defined benefit schemes and so the arrears of her scheme pension will be taxable pension’ income.
Example 4
Kim has exercised her option to receive a lifetime annuity from an insurance company of her choice that does not underwrite the benefits in her pension scheme. There is an administrative delay within her scheme; payment of the consideration to the insurance company to purchase the annuity is delayed, and her lifetime annuity cannot start on time. Until the purchase price is passed to the insurance company, there can be no certainty that the annuity will be secured at a given rate, so the rights remain prospective, and actual entitlement is delayed until an insurance company does accept that payment of the consideration was made. Eventually an insurance company receives the payment for an immediate annuity and are then bound to pay out the annuity from whatever is the start date under the terms of the contract. The date on which payment was effectively made for the annuity becomes the date of ‘actual entitlement’. This is because although Kim completed all the steps that were required of her to obtain the benefit, it was not until payment of the consideration was made to the insurance company that one could define what the entitlement was to. The fact that the annuity is paid monthly in arrears does not affect the actual entitlement date. If the insurance company paying Kim’s annuity had an internal administrative delay resulting in the late payment of her annuity that would not have delayed her actual entitlement either. It is only the scheme delay that extended the final action that Kim performed in choosing the insurance company that would make the annuity payments.
Example 5
On 3 May 2014, Wale designates £10,000 from his pension fund as being available for the payment of a drawdown pension. He has made similar designations in the past. It is another 2 years before Wale actually starts to draw any pension from the designated funds. However for the purposes of the tax rules he is considered to have become actually entitled on 3 May 2014 to a drawdown pension from the £10,000 designated on that day.
What is meant by 'becoming entitled' to a lump sum
Section 166(2) and paragraphs 1 to 3A and 4A Schedule 29
Pension commencement lump sum
For a pension commencement lump sum, the entitlement is normally deemed to arise immediately before the entitlement to the linked scheme pension/drawdown pension/lifetime annuity (see PTM062310). This date may well be different from the date that the lump sum was actually paid, as the lump sum can be paid up to 6 months before or 12 months after the entitlement to it arises.
Where the lump sum is a scheme-specific protected pension commencement lump sum that is linked to a small pension right, and that pension right is in turn paid out as a trivial lump sum (as described at PTM063130), the entitlement to the scheme-specific protected pension commencement lump sum is deemed to arise immediately before the entitlement to the linked trivial lump sum arises.
There are however special rules about the date of entitlement, which apply where a lump sum has been paid in anticipation of entitlement to any of the above kinds of pension arising within the following 6 months, but the member dies before that entitlement actually arises. In such circumstances, the payment may nonetheless be treated as a pension commencement lump sum and entitlement to the lump sum is deemed to have arisen immediately before the member’s death.
Uncrystallised funds pension lump sum
The member becomes entitled to the uncrystallised funds pension lump sum immediately before it is paid.
Other types of lump sum
With any other type of authorised lump sum, the member only becomes ‘entitled’ to it at the point when they first obtain an ‘actual right’ to receive it. This ‘actual right’ has to be distinguished from their ‘prospective right’. An ‘actual right’ is when a member has the right to a lump sum without having to fulfil any further conditions or take any further actions, for example:
having to agree to or authorise the payment of a lump sum, or
having to obtain an employer’s or scheme trustee/scheme administrator’s agreement or co-operation to a lump sum payment.