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HMRC internal manual

Pensions Tax Manual

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Member benefits: lump sums: serious ill-health lump sum

Glossary PTM000001
   

 

Payment of a serious ill-health lump sum
What is meant by an uncrystallised arrangement in the context of paying a serious ill-health lump sum
Size of the serious ill-health lump sum paid before the member reaches age 75 and lifetime allowance issues
Taxation of a serious ill-health lump sum
Reporting payment of a serious ill-health lump sum to HMRC

 

Payment of a serious ill-health lump sum

Sections 636A Income Tax (Earnings and Pensions) Act 2003, 205A Finance Act 2004, 216(1), ‘Event 6’; paragraph 15 Schedule 32 and paragraph 4 Schedule 29

If a member is suffering from serious ill-health (as defined below) then, provided certain conditions are met, the scheme administrator may commute any pension entitlement which that member holds under the scheme and pay them their entire benefit entitlement under an arrangement as a lump sum. This is referred to in the legislation as a serious ill-health lump sum.

Conditions that must be met for a payment to be a serious ill-health lump sum

There is no minimum age for the payment of a serious ill-health lump sum.

The conditions that all must be met in order for a payment to be treated as a serious ill-health lump sum are:

  • before making the payment the scheme administrator has received written evidence from a registered medical practitioner (as defined below) confirming that the member is expected to live for less than one year
  • the member has not used up all of their lifetime allowance at the point the payment is made. The position where the payment, once made, actually breaches the 100 per cent level of the member’s available lifetime allowance is explained later below
  • for payments made before 16 September 2016, the payment extinguishes the member’s entitlement to benefits under the arrangement (this means that all of the benefits under the arrangement must be commuted and paid as a serious ill-health lump sum). Before that date, a serious ill-health lump sum could not be paid from an arrangement that had previously crystallised or paid any benefit, and
  • for payments made on or after 16 September 2016, the payment must extinguish all uncrystallised rights under the arrangement.  If no benefits have yet been taken under the arrangement (none have crystallised so far), this means that all of the rights in the arrangement must be commuted and paid as a serious ill-health lump sum.  If only some benefits have previously crystallised, then the full remainder of uncrystallised rights under the arrangement must be commuted for the serious ill-health lump sum.

The reference to extinguishing the member’s entitlement to benefits or to uncrystallised rights under the arrangement is to all the benefits or rights that could reasonably have been known about at the time of the payment. The lump sum will not cease to be an authorised payment purely because further entitlement is later created that could not have been known about at the time of the initial payment, for example, through a pay revision.  Where because of contracting-out requirements, dependants’ benefits have to be retained under the scheme, then either before or at the time a serious ill-health lump sum is paid, the dependants’ benefits might be moved to a separate arrangement to satisfy the above conditions. This requires no more than documenting the creation of a new arrangement in a manner which is considered acceptable under the scheme.

A registered medical practitioner

Paragraph 4(1)(a) Schedule 29 Finance Act 2004

A registered medical practitioner means a fully registered person within the meaning of the Medical Act 1983. However, in circumstances where the member in ill-health PTM062100 or serious ill-health (as described above) is overseas, the term “registered medical practitioner” may also be interpreted for the purpose of the tax rules as including a certificate from someone with equivalent overseas qualifications.

We would always expect that a member in the UK would need to have evidence from a UK registered medical practitioner.

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What is meant by ‘uncrystallised’ in the context of paying a serious ill-health lump sum

S212(1) & (2), paragraph 4(2) (2A) & (3) Schedule 29 Finance Act 2004

An uncrystallised arrangement is an arrangement in respect of which there has been no previous benefit crystallisation event (BCE) - see PTM088100. If on the other hand, there are only some benefits under the arrangement which are not yet in payment to the member, that is the member has not yet become entitled to the present payment of those benefits, then those are uncrystallised rights.  Where a member has a drawdown pension fund or a flexi-access drawdown fund under the arrangement, they are for this purpose considered to be already entitled to the present payment of the benefit from those funds even if they are not presently drawing any pension from those funds.

Where the member has already reached age 75, any previous BCE 5 or 5B that occurred on reaching that age is ignored when considering if the rights are uncrystallised for this specific test.  This will be so for as long as any such rights have not been put into payment (or designated for payment of drawdown pension) before the serious ill-health payment is to be made.

Article 33 of The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

Where a member was in receipt of a pension from a scheme before 6 April 2006, a serious ill-health lump sum can only be paid in relation to any prospective right to a pension under the scheme on 6 April 2006.

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Size of the serious ill-health lump sum paid before the member reaches age 75 and lifetime allowance issues

Paragraph 12(2) Schedule 29 Finance Act 2004

There are no limits imposed on the payment of a serious ill-health lump sum. Under a money purchase arrangement, the payment will be the funds held in that arrangement. With a defined benefits arrangement, it is for the scheme to attribute a capital value to the pension benefit entitlement being commuted.

The payment of the serious ill-health lump sum is a benefit crystallisation event for lifetime allowance purposes through BCE 6 if it is paid to a member who has not reached the age of 75. The more that is paid, the more that crystallises for lifetime allowance purposes.

Whilst the member must have available lifetime allowance in order for a serious ill-health lump sum to be paid, the level of lump sum paid is not limited by the level of available lifetime allowance that the member actually has (as, for example, a pension commencement lump sum would be). Where the amount crystallising exceeds the available lifetime allowance, the excess creates a chargeable amount.

As the chargeable amount arises from a lump sum payment, the lifetime allowance charge is due at the rate of 55 per cent. The scheme administrator must account for the charge due, and is likely to deduct this charge before paying the serious ill-health lump sum to the member, so the payment will be made net of the 55% lifetime allowance charge due. (See PTM083000 for details for the lifetime allowance charge).

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Taxation of a serious ill-health lump sum

Section 205A and paragraph 11 Schedule 31 Finance Act 2004

Section 636A Income Tax (Earnings and Pensions) 2003

Lump sum paid to a member under 75

There is no charge to income tax either on the individual or the scheme administrator on payment of a serious ill-health lump sum to a member who has not reached the age of 75 (unless the lifetime allowance is an issue - see above).

Lump sum paid to a member paid on or after their 75th birthday

A serious ill-health lump sum paid to a member who has reached the age of 75 is taxed as pension income (at marginal rates) of the recipient member.  However, before 16 September 2016, such payments were subject to the serious ill-health lump sum charge, which was an income tax charge on the scheme administrator at the rate of 45 per cent (55 per cent where paid before 6 April 2015).

Although there is no BCE in relation to the payment, the member must still satisfy the condition that they have available lifetime allowance. When the member reached age 75 the rights from which the lump sum is derived will have been tested against their lifetime allowance under either BCE 5 or BCE 5B - 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 if the member satisfies the condition that they have available lifetime allowance, 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.

On the other hand, 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, see PTM088200 for more details.

For payments made before 16 September 2016, the scheme administrator was the person liable for paying this charge so they normally deducted the tax from the lump sum before payment. (See PTM162100 for Accounting for Tax information).

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Reporting payment of a serious ill-health lump sum to HMRC

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

Regulation 3, ‘reportable Events’ 4 and 6, 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 serious ill-health lump sum to HMRC.

The first circumstance is where the recipient of the payment is:

  • a director of the sponsoring employer of the scheme in the year of payment (or has been in the previous six years) or
  • connected to such a director in the same period, or
  • alone or with others, represented the sponsoring employer in that time, or
  • connected to that employer.

The value of the serious ill-health lump sum paid is not a factor.

The second circumstance is where the member is relying on either an enhanced lifetime allowance entitlement, or an entitlement to enhanced protection, to reduce or eliminate a liability to a lifetime allowance charge on the payment of the serious ill-health lump sum - see PTM092100.

These requirements are explained in more detail in PTM161100.

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