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HMRC internal manual

Pensions Tax Manual

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Member benefits: lump sums: protection of pre-6 April 2006 lump sum rights: enhanced protection and lump sum protection

Glossary PTM000001
   

Lump sum protection available for individuals with enhanced protection
Lump sum rights that exceed £375,000 and enhanced protection: notification and certificate
How protection of lump sum rights works with enhanced protection where lump sum rights exceed £375,000
Enhanced protection and lump sums of more than £375,000: prospective lump sum rights are 100% of rights on 5 April 2006
Scheme chargeable payments: unauthorised lump sum payments

 

Lump sum protection available for individuals with enhanced protection

The guidance on this page applies where the total value of an individuals’ crystallised and uncrystallised lump sum rights on 5 April 2006 is more than £375,000.

If an individual with total lump sum rights of £375,000 or less had on 5 April 2006 in any pension scheme uncrystallised lump sum rights of more than 25% of the value of their total uncrystallised rights in that scheme, see PTM063130.

If an individual with total lump sum rights of £375,000 or less did not on 5 April 2006 have uncrystallised lump sum rights of more than 25% of the value of their total uncrystallised rights in that scheme, there is no lump sum protection. The normal payment rules for pension commencement lump sums apply - see PTM063200.

In an exceptional case, if you should need to consult fuller guidance on valuing lump sum rights in this context, please see page RPSM03105000 in the Registered Pension Schemes Manual, on The National Archives{.ext.no-outline} website (external users please see http://webarchive.nationalarchives.gov.uk/20140504142140/http://www.hmrc.gov.uk/manuals/rpsmmanual/RPSM03105000.htm{.ext}). 

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Lump sum rights that exceed £375,000 and enhanced protection: notification and certificate

Paragraphs 27 and 29 Schedule 36 Finance Act 2004

Regulations 4 and 10 The Registered Pension Schemes (Enhanced Lifetime Allowance) Regulations 2006 - SI 2006/131

Protection was available for total lump sum rights of more than £375,000 at 5 April 2006 for individuals who notified HMRC that they intended to rely on enhanced protection for their pension rights - see PTM092410. This was done by individuals giving details of their lump sum rights when they notified HMRC of their pension rights for enhanced protection.  Details of how lump sum rights at 5 April 2006 were valued is on the National Archives at http://webarchive.nationalarchives.gov.uk/20140504142140/http://www.hmrc.gov.uk/manuals/rpsmmanual/RPSM03105030

Where this was done, HMRC issued a certificate to the individual, confirming enhanced protection. This certificate also shows the percentage of the value of total benefits coming into payment that can be paid as a pension commencement lump sum.

Where this form of lump sum protection applies, it takes precedence over both the lump sum protection for those with dormant primary protection (see PTM063110) and scheme specific lump sum protection (see PTM063130).

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How protection of lump sum rights works with enhanced protection where lump sum rights exceed £375,000

Paragraphs 27 and 29 Schedule 36 Finance Act 2004

Article 18 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 -SI 2006/572

Individuals are able to take a pension commencement lump sum when they take some or all of their pension benefits. Pension commencement lump sums are not, apart from the lifetime allowance charge, subject to income tax. The maximum pension commencement lump sum is 25% of the standard lifetime allowance at the time the lump sum is paid unless an individual has protected lump sum rights.

Enhanced protection of lump sum rights works by:

  • valuing the individual’s uncrystallised lump sum rights (VULSR) at 5 April 2006 and their uncrystallised pension rights (VUR) on 5 April 2006 (see PTM092410),
  • dividing the lump sum rights by the pension rights and multiplying by 100, and expressing the result as a percentage, and
  • modifying what can be taken as a pension commencement lump sum (paragraphs 1 to 3 Schedule 29 Finance Act 2004) so that the individual’s maximum pension commencement lump sum is the amount determined by applying this percentage to the value of total benefits coming into payment under the registered pension scheme. This modification applies to all benefit crystallisation events occurring when the individual has enhanced protection.

A valid claim for enhanced protection coupled with lump sum rights exceeding £375,000 modifies an individual’s authorised lump sum benefits i.e. the amount that they may receive as a pension commencement lump sum at any time after 5 April 2006.

If a scheme provides a lump sum of less than the allowable percentage, the ‘unused portion’ of the percentage cannot be used by another scheme (or by the same scheme at a later benefit crystallisation event). If it is not used it is lost. So for example an individual with enhanced protection has a lump sum percentage of 27%, but one of their schemes only provides a pension commencement lump sum of 25%. The remaining 2% cannot be used at a later benefit crystallisation event.

Whilst an individual has enhanced protection they do not need to have available lifetime allowance to be paid a pension commencement lump sum.

Important note

It is usually possible to pay a lump sum up to 6 months before the recipient becomes entitled to a relevant pension with the intention that the lump sum should be a pension commencement lump sum. Where the recipient dies after receiving the lump sum but before becoming entitled to a relevant pension, the normal provisions of Schedule 29 Finance Act 2004 ensure that the lump sum is still a pension commencement lump sum. But these provisions do not operate where the recipient has enhanced protection and protected lump sum rights, so where such an individual dies after receiving a lump sum but before becoming entitled to a relevant pension that lump sum is an unauthorised member payment.

Where before 6 April 2006 the individual could have taken all their rights from all their pension schemes (that become registered pension schemes on 6 April 2006) as a lump sum, special rules apply. See PTM063130 for more information.

Example of how protection of lump sum rights with enhanced protection works

Sally has enhanced protection and had uncrystallised lump sum rights of £400,000 and uncrystallised pension rights of £2 million on 5 April 2006. The VULSR ÷ VUR formula gives Sally a right to take pension commencement lump sums of 20% of the total value of the benefits as they come into payment. She takes benefits from three schemes on different dates whilst retaining enhanced protection.

Sally takes benefits from the first scheme, which are worth £1 million, by taking drawdown pension. She designates assets valued at £800,000 for the payment of her drawdown pension and takes a lump sum benefit of £200,000. This is the maximum 20% lump sum Sally can take from the scheme as a pension commencement lump sum. She cannot take the higher maximum of 25% allowed under the usual pension commencement lump sum rules. Sally’s notification of enhanced protection has changed the maximum amount of lump sum she can be paid when she crystallises benefits.

Sally takes benefits from the second scheme worth £750,000 in the form of a lifetime annuity bought for £600,000 and a lump sum benefit of £150,000. Again, this is the maximum 20% lump sum Sally can take from the scheme as a pension commencement lump sum.

Sally takes benefits from the third scheme (which is a defined benefits arrangement) as a scheme pension of £20,000 plus a lump sum benefit of £100,000. The scheme pension is valued at £400,000 (20 x the annual pension of £20,000). This is also the maximum 20% lump sum Sally can take from the scheme as a pension commencement lump sum.

If one of Sally’s schemes had paid her a pension commencement lump sum of 15% of the combined value of her lump sum and pension benefits (because the scheme rules did not permit a larger lump sum) her other schemes could not pay her a pension commencement lump sum greater than 20% to make up the “shortfall”.

If Sally had been over age 75 when she took her benefits, the above calculations would still apply to her. This is because although she did not take her pension benefits until after age 75 so they were not benefit crystallisation events, they are treated as though they were to enable the relevant value to be used in the calculation.

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Enhanced protection and lump sums of more than £375,000: prospective lump sum rights are 100% of rights on 5 April 2006

Articles 25 to 25D The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

A pension commencement lump sum cannot be paid where all the benefits are being paid in lump sum form because a pension commencement lump sum must be paid in connection with an arising entitlement to a pension.

Where on 5 April 2006 an individual’s total uncrystallised rights in all relevant pension arrangements could have been taken entirely as a lump sum benefit the individual can still receive all their benefits in lump sum form if certain conditions are met. Where such a lump sum is paid the lump sum is called a stand-alone lump sum.

A stand-alone lump sum may be payable to an individual with enhanced protection where

  • on 5 April 2006 all the member’s rights under all schemes (that became registered pension schemes on 6 April 2006 under the provisions of paragraph 1(1) Schedule 36) could have been paid out as a tax-free lump sum without giving HMRC grounds for withdrawing scheme approval. In making this test, it is assumed that the member has left employment and that HMRC would allow the immediate lump sum payment on 5 April 2006 whatever the member’s age without affecting the scheme’s approval. In valuing the lump sum rights, it should also be assumed that if the member was not old enough to take an unreduced lump sum under the scheme rules on 5 April 2006, the benefit should be calculated assuming the individual to be 60 years of age - unless a different age was specified under the arrangement on 10 December 2003 as the age at which no reduction would apply to the payment of an immediate benefit, in which case the individual should be assumed to be that age
  • all the benefits are paid out from a pension scheme at the same time, as a single benefit crystallisation event (BCE), and
  • the member has reached the normal minimum pension age (or any earlier protected pension age they may have under the scheme - see PTM062210) or is taking benefits earlier due to ill-health - see PTM062100.

Payment of a stand-alone lump sum is a benefit crystallisation event (BCE 6) if it occurs before age 75. This is because the only benefit crystallisation event which can occur after age 75 is BCE 3, which can only occur when there is an increase in a scheme pension (see PTM088630). The stand-alone lump sum is not liable to income tax (except for tax under the lifetime allowance charge), so whilst the member has valid enhanced protection the stand-alone lump sum is tax free.

Amount of stand-alone lump sum

There is no set upper limit on the amount of stand-alone lump sum whilst the member has valid enhanced protection.

Other money purchase arrangements can pay a stand-alone lump sum which includes the full investment return on the value of the lump sum rights as at 5 April 2006 even though this is more than the 5 April 2006 value indexed in line with the standard lifetime allowance or, from 6 April 2012, increased by 20% if the lump sum is taken in a tax year when the standard lifetime allowance is less than £1.8 million.

Defined benefits or cash balance arrangements can pay a stand-alone lump sum up to the amount of the appropriate limit. (PTM092430 explains what the appropriate limit is).

Transfers causing loss of right to a stand-alone lump sum

The right to a stand-alone lump sum will be lost if a transfer is received from a pension scheme that is not a registered pension scheme.

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Scheme chargeable payments: unauthorised lump sum payments

Paragraph 30 Schedule 36 Finance Act 2004

Paragraph 30 Schedule 36 Finance Act 2004 exempts scheme administrators in specified circumstances from a tax charge that would otherwise apply under section 239 Finance Act 2004.

Section 239 Finance Act 2004 levies a tax charge called the scheme sanction charge where the scheme makes an unauthorised payment. Under paragraph 30 of Schedule 36 Finance Act 2004, this tax charge will not arise where:

  • an unauthorised lump sum payment is made,
  • the recipient makes or has already made a valid claim for primary protection and/or enhanced protection and their lump sum rights exceeded £375,000 in value on 5 April 2006, and
  • the lump sum paid to the recipient would have been an authorised payment (a pension commencement lump sum had the operation of paragraphs 2 and 3 Schedule 29 not been modified to reduce the permitted maximum or applicable amount because the recipient had protected lump sum rights.

The effect of paragraph 30 is that a scheme administrator is not liable to a tax charge when paying a lump sum not exceeding 25% of the value of the benefits coming into payment to a recipient who has not used up all of their standard lifetime allowance. The excess amount is however still an unauthorised member payment so the member will still be liable to the unauthorised payments charge.