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Pensions Tax Manual

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Member benefits: lump sums: Pension commencement lump sum (PCLS): payments

Glossary PTM000001
   

Payment of a pension commencement lump sum
Pension commencement lump sum conditions
What is meant by “a relevant pension”
An excluded lump sum for pension commencement lump sum purposes
Taxation issues surrounding payment of a pension commencement lump sum
A pension commencement lump sum can be paid from an overpaid lifetime allowance charge reclaimed from HMRC
Reporting payment of a pension commencement lump sum to HMRC

Payment of a pension commencement lump sum

Paragraph 1 Schedule 29 Finance Act 2004

When a member has become or is to become entitled to certain authorised pension benefits under an arrangement under a registered pension scheme then, subject to certain conditions, the scheme may also provide that member with a level of tax-free lump sum.

Such a payment is referred to in the legislation as a pension commencement lump sum.

The conditions required for a lump sum paid by a scheme to a member to be a pension commencement lump sum (and therefore be tax-free) are set out on PTM063220.

The legislation limits how much of a lump sum may count as a tax-free pension commencement lump sum. That limit is known as the permitted maximum. Anything paid above the permitted maximum is not a pension commencement lump sum (see PTM063230). However, if the excess is covered by The Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171, the excess amount may nonetheless be accepted as an authorised payment and treated under the tax rules as a pension commencement lump sum. Also, in certain circumstances a payment representing an intended pension commencement lump sum can be paid as an authorised member payment after the member has died. This can apply where a payment was due under scheme rules but entitlement under the tax rules was not established before the member died. See PTM063270 for further details.

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Pension commencement lump sum conditions

Paragraph 1(1) and (2) Schedule 29 Finance Act 2004

There are various conditions that a lump sum paid by a scheme to a member must meet in order to be a pension commencement lump sum. These conditions effectively define a pension commencement lump sum, and are as follows.

Entitlement to pension

The member’s lump sum entitlement must be connected to an arising entitlement to a ‘relevant pension’ benefit under the same registered pension scheme. Explanations of when entitlement to different forms of pension benefit arise in different circumstances, and the meaning of entitlement in relation to a lump sum are at PTM088200. See information later below where a lump sum is paid in anticipation of being entitled to the ‘relevant pension’ but the member dies before that entitlement arises.

There is also an exception to the rule that a pension commencement lump sum must be paid in connection with a relevant pension if the member qualifies for scheme specific lump sum protection (see PTM063130). Where the conditions are met, a trivial lump sum may be paid instead of a connected ‘relevant pension’.

Lifetime allowance available

The member must not have used up all their lifetime allowance at the time of payment.

Where the lump sum is to be paid before the member’s 75th birthday, the scheme administrator will want to find out before the lump sum is paid whether the member has available lifetime allowance, as the lump sum triggers a lifetime allowance test through BCE 6 - see PTM088670. Where the lump sum is being paid after age 75 from uncrystallised funds or rights, those funds or rights will have already been tested against the member’s lifetime allowance under BCE 5 or BCE 5B respectively when the member reached age 75 (see PTM088650). This BCE will have used up some or all of the member’s available lifetime allowance at that time.

So, solely for the purposes of deciding whether the member satisfies the condition that they have available lifetime allowance, when they take a pension commencement lump sum after age 75:

  • the fact that a BCE 5 or BCE 5B has occurred is disregarded. This means that any lifetime allowance used up by that BCE does not count in calculating whether the member has available lifetime allowance, and
  • if the member has already taken benefits from the same or another arrangement under a registered pension scheme after reaching age 75 or some other event has occurred that would have been a BCE but for the fact that the event occurred on or after the member reaching age 75, then, again solely for the purposes of calculating whether the member has available lifetime allowance, those events are treated as though they were BCEs and so are treated as having used up lifetime allowance.

Timing of payment

The lump sum must be paid within an 18-month period starting 6 months before and ending 12 months after the member becomes entitled to it. Entitlement to the pension commencement lump sum arises on the day that actual entitlement (as opposed to prospective entitlement) to the linked relevant pension arises (see PTM088200).

SI 2006/135 The Registered Pension Schemes (Meaning of Pension Commencement Lump Sum) Regulations 2006 as amended by SI 2007/3533

The requirement that a pension commencement lump sum must be paid within an 18-month period starting 6 months before and ending 12 months after the entitlement arising to that lump sum payment does not apply where payment of such a lump sum has been restricted incorrectly due to the underestimation of the member’s available lifetime allowance, and any excess lifetime allowance charge paid by the scheme administrator has subsequently been refunded to the scheme - see PTM085000 and A pension commencement lump sum can be paid from an overpaid lifetime allowance charge reclaimed from HMRC (below). If the further lump sum is paid within 12 months of the scheme receiving the refund from HM Revenue & Customs, it can still be treated as a pension commencement lump sum providing all the other conditions are met.

Minimum age

The lump sum must not be paid until the member has reached normal minimum pension age. In some cases the normal minimum pension age may be replaced by a lower protected pension age (see PTM062210). Additionally, payment may be made before normal minimum pension age (or the member’s protected pension age, if appropriate) where the entitlement to a relevant pension arises because the individual meets the ill-health condition (see PTM062100).

Excluded lump sum

The lump sum payment must not be what the legislation defines as an excluded lump sum (see later below).

Permitted maximum

The amount which can be treated as a pension commencement lump sum is an amount which does not exceed the permitted maximum (see PTM063230).

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What is meant by “a relevant pension”

The definition of relevant pension includes income withdrawal, a lifetime annuity or a scheme pension. PTM063230 explains why we link the lump sum payment to an entitlement to income withdrawal, but not to the purchase of a short-term annuity contract.

Paragraph 28 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

Where a member of a scheme within paragraph 1(1) (a), (c) or (e) of Schedule 36 of the Finance Act 2004 (as listed below) had taken a lump sum before 6 April 2006 but on or after 27 July 2004 had elected to defer entitlement to the related pension until after 5 April 2006 no further lump sum can be paid in respect of the pension. The deferred pension is not a relevant pension.

The scheme types concerned are:

  • Retirement benefit schemes approved under Chapter 1 of Part 14 of Income and Corporation Taxes Act 1988 (commonly known as an approved occupational pension scheme). This includes Additional Voluntary Contribution (AVC) schemes.
  • Relevant statutory schemes (more commonly known as public sector pension schemes), which are not approved schemes. Examples include schemes such as those for employees of the NHS, civil service, police, fire, armed forces, teachers, Parliament and National Assemblies, and also schemes not established by statute but which have been treated as statutory schemes.
  • Certain deferred annuity contracts which, although not approved pension schemes prior to 6 April 2006, were automatically treated as registered pension schemes from 6 April 2006.
  • Schemes or funds mentioned in section 613(4) (b) to (d) of ICTA (Parliamentary pension schemes or funds).

Where sums or assets in respect of a deferred pension from one of the types of scheme listed above have been transferred to another registered pension scheme, these restrictions will continue to apply to the new scheme, so that the pension is not a relevant pension and no further pension commencement lump sum can be taken.

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An excluded lump sum for pension commencement lump sum purposes

Paragraph 1(1)(f) and (4) Schedule 29 Finance Act 2004

A lump sum payment is an excluded lump sum if:

  • it is paid in connection with an arising entitlement to a scheme pension which is a bridging pension that will be reduced or stopped at a time not earlier than when the member reaches the age of 60 and not later than when the member reaches the age of 65 or their state pension age if this is later - see PTM062340, and
  • the sole or main purpose of making provision for such a bridging pension was to increase the member’s potential entitlement to a pension commencement lump sum.

An excluded lump sum is not a pension commencement lump sum but is an unauthorised member payment, to the extent that the individual’s lifetime allowance is not exhausted. PTM131000 explains how an unauthorised member payment is taxed. Any payment made when the member’s available lifetime allowance has been exhausted is a lifetime allowance excess lump sum, subject to a 55% lifetime allowance charge. See PTM084000

The maximum pension commencement lump sum that may be paid where a scheme pension is being provided is directly linked to the level of pension in payment in the first 12 months after the entitlement arises. So the higher the starting value, the higher the level of pension commencement lump sum that can be paid. The excluded lump sum rule is an anti-avoidance rule to prevent individuals getting higher tax-free lump sums by setting up a bridging pension, thus inflating the initial pension level in order to provide a larger tax-free pension commencement lump sum than would otherwise have been payable.

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Taxation issues surrounding payment of a pension commencement lump sum

Sections 208 to 212, 239, 240 and 241 and paragraph 11 Schedule 31 Finance Act 2004

The Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171

Section 636A(5) Income Tax (Earnings and Pensions) Act 2003

A pension commencement lump sum is paid tax-free.

Where a lump sum that exceeds the permitted maximum is paid to a member from a scheme, the excess is not a pension commencement lump sum and so does not benefit from tax-free treatment. However, if the excess is authorised by the Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171) then the excess amount can nonetheless be accepted as an authorised payment and treated under the tax rules as a pension commencement lump sum. See PTM063260 for further details.

If the excess lump sum does not fall within any of the relevant provisions of SI 2009/1171 or within the definition of any of the other error payments (see PTM146000) it is an unauthorised member payment. That element of the lump sum that is an unauthorised member payment is not included in the amount crystallised for lifetime allowance purposes.

The unauthorised member payment is subject to an unauthorised payments charge. The payment may also trigger an additional income tax surcharge on the member (an unauthorised payments surcharge). The payment may also give rise to a scheme sanction charge on the scheme administrator. More information on these tax charges can be found at PTM131000.

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A pension commencement lump sum can be paid from an overpaid lifetime allowance charge reclaimed from HMRC

The Registered Pension Schemes (Meaning of Pension Commencement Lump Sum) Regulations 2006 - SI 2006/135

Where a scheme administrator has made a payment of lifetime allowance charge in respect of a member and it is later found that there was an overpayment of the charge, the scheme administrator can reclaim the overpayment back from HMRC.

When HMRC refunds the overpaid lifetime allowance charge back to the scheme administrator, the scheme administrator may use part or all of the refund to pay a further lump sum. If the scheme administrator pays the lump sum within 12 months of the day it receives the refund of the overpaid lifetime allowance charge from HMRC, it can be treated as a pension commencement lump sum for tax purposes.

The other pension commencement lump sum conditions must of course also be satisfied; e.g. there is a maximum that can be treated as a pension commencement lump sum (see above).

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Reporting payment of a pension commencement lump sum to HMRC

Section 251(1) (a) and (4) (a) Finance Act 2004

Regulation 3, ‘reportable events 7 and 8’, The Registered Pension Schemes (Provision of Information) Regulations 2006 - SI 2006/567

There are two circumstances where the scheme administrator must report the payment of a pension commencement lump sum to HMRC. Both these circumstances relate to the protection of rights accrued before 6 April 2006. The circumstances are described from PTM161000.

Section 98 Taxes Management Act 1970

A scheme administrator failing to make the required report will become liable to penalties - see PTM160800.