PTM062310 - Member benefits: pensions: scheme pensions: overview
As of 6 April 2024 there is no longer lifetime allowance. If you are looking for information about protections, enhancement factors and the lifetime allowance charge please see these pages on The National Archives. If you are looking for information about the principles of lifetime allowance and benefit crystallisation events please see these pages of The National Archives.
Glossary PTM000001
A scheme pension
Commencement of a scheme pension
Requirements for a pension to be a scheme pension
Guaranteed pension
Provision of a scheme pension
Provision of a scheme pension by a defined benefits arrangement
Provision of a scheme pension by a money purchase arrangement
Provision of a scheme pension by a collective money purchase arrangement
A secured pension and phased retirement
Taxation of scheme pensions
A scheme pension
Section 165 pension rules 3, 4 and 6 and paragraph 2 schedule 28 Finance Act 2004
As an alternative to drawdown or uncrystallised funds pension lump sums, a money purchase arrangement, that is not a collective money purchase arrangement, may provide its members with a secured pension, either:
- paid direct from the scheme as a scheme pension
- by purchasing a lifetime annuity contract from an insurance company (see PTM062320).
The legislation sets out conditions that a pension entitlement must meet to be treated as a scheme pension for tax purposes.
If any pension paid from the scheme is not a scheme pension, those payments will be unauthorised member payments (unless of course the pension is another form of authorised pension payment) and will be taxed accordingly.
Section 165 pension rules 3, 4 and 6 and paragraph 2 schedule 28 Finance Act 2004
A scheme pension is the only way a defined benefits arrangement or a collective money purchase arrangement may provide its members with a pension benefit. It is also possible for a money purchase arrangement to provide a scheme pension.
Further information below explains what a scheme pension is, and the conditions governing such pensions.
Commencement of a scheme pension
Scheme pensions do not have to be provided by age 75 - they can come into payment at any time from when the member reaches normal minimum pension age (currently age 55 but this will increase to age 57 from 6 April 2028).
Requirements for a pension to be a scheme pension
Paragraph 2 schedule 28 Finance Act 2004
To be a scheme pension the pension must:
- be paid for the life of the member
- be paid at least annually
- not be capable of being reduced year on year (except in limited circumstances - see PTM062340), and
- be paid by the scheme administrator (or by an insurance company chosen by the scheme administrator).
Guaranteed pension
Paragraph 2(3)(a) schedule 28 and paragraph 14 schedule 29 Finance Act 2004
A scheme pension may be guaranteed for a set period of up to 10 years - for more detail see PTM062320.
A scheme pension may also be provided with pension protection - see PTM073300.
Provision of a scheme pension
Section 165(1) pension rules 3 and 4 Finance Act 2004
A scheme pension may be provided under a defined benefits arrangement or a money purchase arrangement. In both cases, the scheme pension may be either paid direct from the scheme by the scheme administrator, or secured with an insurance company chosen by the scheme administrator. If the pension is secured through an insurance company, the policy may be in the name of the scheme trustees or in the name of the member. If the policy is in the name of the member, pension payments will normally pass directly from the insurer to the member. If the policy is in the name of the trustees then the payment of pensions is likely to be arranged to go from the insurer to the scheme and then from the scheme to the member, although it is possible that the insurance contract may provide for the insurer to act as the trustees’ paying agent and pay the member direct.
Provision of a scheme pension by a defined benefits arrangement
Where a scheme provides a member with a scheme pension through a defined benefits arrangement, the member is being provided with a pension entitlement for life, at a certain rate, from the scheme itself. For example, in an occupational pension scheme, the scheme or employer promises the member a scheme pension for life, starting from a given date, at a given rate, based on specific factors, such as length of service, remuneration and so on, specific to that individual’s employment with that employer. Whilst a member may be required to contribute to the scheme at a certain level, the amount they pay does not affect their level of entitlement under the scheme.
Generally, the scheme pension will be paid direct from the scheme by the scheme administrator. The scheme administrator may choose to secure all or part of the scheme’s liability, by purchasing an annuity contract with an insurance company as described above - also see PTM062320.
Provision of a scheme pension by a money purchase arrangement
Where there are money purchase arrangements under a scheme, the member must be allowed to purchase a lifetime annuity with an insurer of their choice but they may also be offered the option of drawing a scheme pension. The level of scheme pension promised will only be set at that time, based on the level of funds accumulated on behalf of that member at that time.
Generally, the scheme will only provide the option of drawing a scheme pension under a money purchase arrangement through the involvement of an insurance company at the time entitlement arises.
More information on providing a scheme pension under a money purchase arrangement is at PTM062330.
Provision of a scheme pension by a collective money purchase arrangement
Section 165(1) pension rules 3 and 4 Finance Act 2004
A collective money purchase arrangement can only pay pension benefits as a scheme pension. Unlike a defined benefits arrangement, payment of a scheme pension under a collective money purchase arrangement may fluctuate year on year depending on the performance of the collective fund.
A secured pension and phased retirement
Section 165(3) Finance Act 2004
Provided the scheme rules allow it, a member does not have to draw benefits from all the funds held in an arrangement or draw all of their pension entitlement at the same time. They can choose to draw only part of their entitlement or designate that only part of the funds held in the arrangement are used (or made available) to provide benefits.
So, a member can choose to use only some of the funds held in an arrangement to secure a lifetime annuity, or choose to draw only part of their scheme pension entitlement direct from the scheme. Any tax-free pension commencement lump sum paid in association with that pension benefit will be proportionate to the level of pension benefits being drawn.
The precise level of flexibility open to the member will depend entirely on the scheme rules.
A money purchase arrangement
Section 165(3) and paragraphs 8 and 10 schedule 28 Finance Act 2004
With a money purchase arrangement, any uncrystallised funds held in the arrangement remain invested within the fund (separately from any funds held in a drawdown pension fund or a flexi-access drawdown pension fund for the member).
All or part of those uncrystallised funds can then be used to purchase a lifetime annuity contract or scheme pension at a later date, or be designated to provide additional drawdown pension. All or part of the benefits under a money purchase arrangement can begin to be paid after the member’s 75th birthday.
A defined benefits arrangement
Section 155(3) Finance Act 2004
Under a defined benefits arrangement there is no fund value held in the arrangement; there is simply an entitlement to a certain level of scheme pension. That pension will be given a certain notional transfer value by the scheme, but there is no actual fund value held in the arrangement earmarked to that member.
A scheme may allow a member to split their scheme pension entitlement by drawing part of their pension entitlement and deferring the rest to a later date. Those deferred benefits may later be augmented.
Taxation of scheme pensions
Sections 579A to 579D Income Tax (Earnings and Pensions) Act 2003
The income received from a scheme pension from a registered pension scheme is subject to Income Tax. The recipient is charged Income Tax at their marginal rate on the amount they are entitled to receive in a tax year. The payer of the pension must operate PAYE in accordance with the PAYE rules before paying the pension.
Any unauthorised pension paid under a registered pension scheme will not be chargeable to Income Tax as pension income. For more details about the unauthorised payments charge see PTM134100.
Certain authorised lump sum payments are also taxable as pension income. See PTM063700.