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Pensions Tax Manual

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Member benefits: lump sums: trivial commutation lump sum

Glossary PTM000001
   

 

Scope

Overview of commutation of benefit rights
When benefits may be commuted and paid as a trivial commutation lump sum
What pension rights are measured against the commutation limit
What benefits may be commuted
Amount of payment
The nominated date for valuing pension rights and the commutation period
12-month window
Conditions that must be met for a payment to be a trivial commutation lump sum
Relevant crystallised pension rights
Valuing uncrystallised rights
Process the scheme administrator must go through
Contributions or accrual after the nominated date
Taxation

 

 

Scope

If the commutation period began before 27 March 2014, please refer to the archived version of this manual in The National Archives.

The guidance below sets out the tax position from 16 September 2016.  To apply it to payments before 16 September 2016 but in respect of commutation periods starting on or after 27 March 2014, bear in mind the following historical changes.

Where the commutation period began on or after 27 March 2014 but before 6 April 2015

  • the minimum age for paying the lump sum was 60 and
  • trivial commutation lump sums could be paid in respect of any kind of arrangement listed at PTM023200.

For commutation periods starting on or after 6 April 2015:

  • the minimum age for paying the lump sum became the minimum pension age of 55 or a lower age if in ill-health (see PTM062100) or if the member had a protected pension age (see PTM062210), and
  • trivial commutation lump sums could only be paid in respect of defined benefits arrangements (but valuation against the commutation limit still involved rights from all types of arrangements).

For payments made on or after 16 September 2016, trivial commutation lump sums can only be paid in respect of:

  • defined benefits arrangements, or
  • ‘in-payment money-purchase in-house scheme pensions’ as explained below on this page.

The valuation rules are unchanged and valuation against the commutation limit still involves rights from all types of arrangements.

Overview of commutation of benefit rights

Section 164(1)(f) and paragraphs 7 to 9 Schedule 29 Finance Act 2004

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

The legislation provides for certain types of benefits rights under a registered pension scheme to be commuted and paid as a one-off authorised lump sum if the payment meets all the legislative conditions required to qualify as a trivial commutation lump sum (the guidance on this page explains what those conditions are).

There is further guidance on page PTM063700 on the tax treatment of a range of other small lump sum payments made to or in respect of a scheme member, typically following the discovery of certain errors, unanticipated rights or to resolve certain obligations.

If the required conditions are not met, the payment will only be authorised if it meets the conditions for some other kind of authorised payment. HMRC has no discretion under the tax legislation to authorise other problematic types of payments that are not covered by the authorised payment rules. Unauthorised payments will be subject to tax charges as outlined in PTM131000.

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When benefits may be commuted and paid as a trivial commutation lump sum

For payments made in the past, please read the Scope section at the top of this page.

Paragraphs 7 to 9 Schedule 29 Finance Act 2004

Providing the other conditions are met (as described below) defined benefits and any ‘in-payment money-purchase in-house scheme pensions’ may be commuted and paid as a one-off lump sum that is an authorised payment once the member has reached the age of 55 or is entitled to take their benefits before age 55 because they either meet the ill-health condition (see PTM062100) or have a protected pension age (see PTM062210).

One of the conditions is that the value of the member’s benefit entitlements under all registered pension schemes, along with all rights that have previously crystallised for lifetime allowance purposes (including any pensions in payment on 5 April 2006), do not exceed a maximum value (the commutation limit) as valued on a specific date (the nominated date). See later below for explanations of what pension rights are valued for the purposes of this limit.

Where the value of these combined pension rights does not exceed the commutation limit on the nominated date, then any of those rights that are either in respect of a defined benefits arrangement or are ‘in-payment money-purchase in-house scheme pensions’ may be paid out as trivial commutation lump sums in a specified 12-month commutation period. This period is set by reference to the first trivial commutation lump sum payment by any scheme for that member. That first payment must be made within three months of the nominated date. (See below for more details).

An individual can have only one 12-month commutation period in their lifetime. So if the member has rights in multiple registered pension schemes, but does not commute them all within the commutation period, those rights will not be able to be commuted later under this rule.

All the defined benefit rights (including any in payment) under the scheme and any ‘in-payment money-purchase in-house scheme pension’ the member has under a registered pension scheme must be commuted if a trivial commutation lump sum is to be paid from that scheme. However, if the individual holds such rights under more than one scheme, they are not required to commute those benefits under every scheme. They can commute their defined benefits held under one scheme, but not those under another.

Commutation limit

Paragraph 7(4) Schedule 29 Finance Act 2004

The commutation limit is £30,000.

Lifetime allowance

Paragraphs 7(1)(c) and 12(2) Schedule 29 Finance Act 2004

Paragraph 15 Schedule 32 Finance Act 2004

The payment of a trivial commutation lump sum is not a BCE so it does not trigger a lifetime allowance test. However, for the lump sum payment to be an authorised payment, the member must have some available lifetime allowance at the point the lump sum is paid.

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What pension rights are measured against the commutation limit

For payments made in the past, please read the Scope section at the top of this page.

Paragraphs 7(5), 8 and 9 Schedule 29 Finance Act 2004

All of the member’s crystallised and uncrystallised rights under any kind of arrangement are valued on the nominated date and compared to the commutation limit.

Details on how these respective values are calculated are given later below. The valuation of the pension rights includes the individual’s benefit entitlements, past and present, including all amounts crystallised previously for lifetime allowance purposes in respect of that individual under all registered pension schemes. See PTM088100. Whilst any earlier BCEs will in all likelihood relate to the payment of benefits and the commencement of a pension entitlement, they may not - for example, a transfer overseas (BCE 8 - PTM088690).

Any rights that were commuted on grounds of triviality before 6 April 2006 are not included in the calculation.

Any small lump sum (see PTM063700) that was paid before the nominated date (see below) is not included in the member’s relevant crystallised rights. Only payments that were BCEs are included as relevant crystallised rights - small lump sums do not count towards the lifetime allowance.

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What benefits may be commuted

For payments made in the past, please read the Scope section at the top of this page.

Uncrystallised defined benefits rights (see PTM023300), defined benefits scheme pensions in payment (PTM062310) and ‘in-payment money-purchase in-house scheme pensions’ may all be commuted. The same conditions must be met in each case.

Where specifically identifiable contingent beneficiary’s benefits/rights exist within the above, these too must be commuted with the member’s benefits. They must be included when valuing the member’s pension rights (see below).

In-payment money-purchase in-house scheme pension

An ‘in-payment money-purchase in-house scheme pension’ is a scheme pension payable by the scheme adminstrator, to which the member has become entitled under a money purchase arrangement.

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Amount of payment

For payments made in the past, please read the Scope section at the top of this page.

It is for the scheme to attribute a capital value to the pension benefit being commuted. The amount of lump sum actually paid may not necessarily be the same as the value attributed to those benefits as valued on the nominated date on the prescribed basis. What matters is that the benefits were valued on the prescribed basis for commutation limit purposes, did not in aggregate with rights beyond the scheme exceed the commutation limit on the nominated date (see below) and the payment otherwise satisfies the conditions for a trivial commutation lump sum.

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The nominated date for valuing pension rights and the commutation period

For payments made in the past, please read the Scope section at the top of this page.

Paragraph 7(2) and (3) Schedule 29 Finance Act 2004

A registered pension scheme may pay a member a trivial commutation lump sum only if their pension rights are valued at no more than the commutation limit on the nominated date. The member must have the opportunity to nominate the date when their pension rights are valued for triviality purposes. The nominated date must fall either on the first day of the commutation period, or within the 3-month period ending on that first day. The member can therefore plan when the 12-month period will run from, and this will dictate the period the nominated date must fall within. However, the nominated date cannot be earlier than 3 months before the first trivial commutation lump sum is paid to the member by any registered pension scheme.

A trivial commutation lump sum can only be paid on or after the member’s 55th birthday unless they are able to take benefits as authorised payments before that age because they either meet the ill-health condition (see PTM062100) or have a protected pension age (see PTM062210). This age is the earliest date the commutation period can start from and it follows that the nominated date cannot be earlier than 3 months before that date.

If the member fails to select the nominated date, by default the first day of the commutation period will be the nominated date.

Examples about commuting trivial benefits can be found later below.

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12-month window

Paragraph 7(1)(a) Schedule 29 Finance Act 2004

The individual has a one-off 12-month period to commute trivial funds across all their schemes.

Any commuted lump sum paid after the 12-month period has ended will not qualify as a trivial commutation lump sum.

The individual may choose to commute trivial benefits in any 12-month period beginning on or after their 55th birthday unless they are able to take benefits as authorised payments before that age because they either meet the ill-health condition (see PTM062100) or have a protected pension age (PTM062210).

The commutation period starts on the day the first commutation payment is made.

For payments made in the past, please read the Scope section at the top of this page.

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Conditions that must be met for a payment to be a trivial commutation lump sum

For payments made in the past, please read the Scope section at the top of this page.

Paragraph 7(1)(a) to (e) Schedule 29 Finance Act 2004

The six conditions that a lump sum payment must meet to be a trivial commutation lump sum for payments made on or after 16 September 2016 are as follows:

  • the member has not been paid a trivial commutation lump sum previously (from any registered pension scheme), except any earlier payment within the commutation period,
  • the lump sum is paid in respect of a defined benefits arrangement or an in-payment money-purchase in-house scheme pension, or both,
  • on the nominated date, the value of the member’s pension rights do not exceed the commutation limit of £30,000,
  • the lump sum is paid when the member has available lifetime allowance,
  • the lump sum extinguishes the member’s entitlement to defined benefits and in-payment money-purchase in-house scheme pensions under the registered pension scheme making the payment, and
  • the lump sum is paid when the member has reached the age of 55 or meets the ill-health condition (see PTM062100) or has a protected pension age (see PTM062210).

The reference to extinguishing the member’s entitlement to benefits under the scheme is to all the 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 specifically identifiable contingent beneficiary’s benefits/rights exist under the scheme in relation to the member’s rights that are commutable above, these must be extinguished along with the member’s own entitlement to such benefits.

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Relevant crystallised pension rights

For payments made in the past, please read the Scope section at the top of this page.

Paragraph 8 Schedule 29 and paragraph 10 Schedule 36 Finance Act 2004

Regulations 13 and 14, The Registered Pension Schemes (Provision of Information) Regulations 2006 - SI 2006/567

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Valuing pension rights for trivial commutation purposes: relevant crystallised pension rights

For trivial commutation purposes any benefits that have previously been drawn or crystallised by the individual (or have been deemed to crystallise for lifetime allowance purposes) under any registered pension scheme or previously tax approved pension scheme, whether before, on or after 6 April 2006, must be valued, along with any uncrystallised pension rights of the individual.

A member’s relevant crystallised pension rights are made up of two elements:

  • the amounts that have crystallised previously for lifetime allowance purposes in respect of the individual (that is, all the BCEs that have occurred for the individual on or since 6 April 2006) - see PTM088100, and
  • the crystallised value, as measured for lifetime allowance purposes, of any pensions that were in payment to that individual on 5 April 2006 (relevant existing pensions) - see PTM088300.

How these two elements of an individual’s relevant crystallised pension rights are valued is explained next.

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Valuing relevant crystallised pension rights: the crystallisation of benefits on or after 6 April 2006

After a BCE occurs, the scheme administrator will provide the member with a statement confirming the amount that individual has crystallised for lifetime allowance purposes under that scheme, both at that event and any earlier events. The statement will confirm the total percentage of the standard lifetime allowance that has been crystallised in respect of the individual under the scheme. This certificate will be sent either once every tax year up to and including the tax year in which the member reaches age 75 or, where no pension is in payment under the scheme, within 3 months of the BCE.

This percentage value is applied to the level of standard lifetime allowance that applies for the tax year in which the original BCEs fell, to obtain the value of an individual’s crystallised pension rights under that scheme on that date.

Example - pension and lump sum came into payment on or after 6 April 2006

In the 2007-08 tax year Catherine started drawing a scheme pension of £700 per annum and was paid a pension commencement lump sum of £2,000 in relation to that pension.

The amount that crystallises at the two BCEs that occurred in 2007-08 is £14,000 through BCE 2 in respect of the arising scheme pension entitlement (20 x £700) and £2,000 through BCE 6 in respect of the lump sum paid. This is £16,000 in total.

If Catherine wants to take these or other benefits as a trivial commutation lump sum, the value taken into account for these crystallised benefits is a total of £16,000.

Paragraph 8 Schedule 29 and paragraph 10 Schedule 36 Finance Act 2004

A pension that was in payment on 5 April 2006 is valued by reference to the level of that pension being paid on that date (not at any later BCE or on the nominated date).

So the crystallised value is calculated in the same way as explained in PTM088300, usually by multiplying the annual rate of the pension in payment as at 5 April 2006 by a conversion factor of 25.

There is no need to consider any tax-free lump sums paid before 6 April 2006. This is because of the higher conversion factor of 25 (which is set at that level on the assumption that a tax-free lump sum would have been drawn at the time the pension came into payment).

Example - pension and lump sum came into payment before 6 April 2006

On 1 January 2015 Catherine is in receipt of an annual pension of £2,000 per annum. She started receiving this pension in 2001.

This pension is being valued in relation to a nominated date of 1 June 2015.

The above pension is considered for commutation limit purposes on the basis of its annual rate as at 5 April 2006. At this date the pension was being paid at the rate of £1,500 per annum.

So the crystallised value at that date is £37,500 (£1,500 x 25). This is the value to take into account for these crystallised benefits when considering whether Catherine is within the trivial commutation limit. As this value is more than the £30,000 commutation limit, no further lump sum can be paid as a trivial commutation lump sum.

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Valuing uncrystallised rights

For payments made in the past, please read the Scope section at the top of this page.

Section 212 and paragraph 9 Schedule 29 Finance Act 2004

Any rights the individual holds under any registered pension schemes that have not crystallised for lifetime allowance purposes, that is, where no right to a benefit in payment has arisen yet, must be included in the pension rights valuation for trivial commutation purposes. This will include any uncrystallised rights that the member wishes to commute.

As these benefits have not crystallised for lifetime allowance purposes, a capital value will not have been attributed to these uncrystallised rights. The way to value these uncrystallised rights depends on whether those rights are held in a cash balance arrangement, money purchase arrangement, defined benefits arrangement or a hybrid arrangement.

PTM134500 explains how the value of these uncrystallised rights is calculated for each of the four types of arrangement.

For the avoidance of doubt, there is no distinction for the above purposes between rights that have accrued direct in an arrangement, and those that have been transferred in. The term uncrystallised rights includes all the member’s uncrystallised rights under the arrangement.

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Process the scheme administrator must go through

For payments made in the past, please read the Scope section at the top of this page.

Sections 239 and 268 Finance Act 2004

A registered pension scheme must take reasonable steps to ensure that any payment they make is authorised, within the meaning of Chapter 5, Finance Act 2004.

If they fail to take such steps, and it transpires that a payment made is an unauthorised member payment, the scheme will become liable to pay a scheme sanction charge (unless the payment falls within narrowly defined circumstances).

Where the authorisation of a payment is conditional on matters which are known only by the member, schemes will need to ask the member to supply sufficient information so that the scheme is satisfied that those conditions are met. For example, they will want to be satisfied that all that member’s pension rights are within the commutation limit on the nominated date.

If the member has pension benefits with other schemes, the commuting scheme will have to ask the member about the value of those benefits, so that it can confirm that the total value of the member’s pension rights falls within the commutation limit.

Where a member gives a scheme inaccurate information or makes a false statement, so that a payment which a scheme considered to be authorised turns out not to be, the scheme can seek discharge from any resulting scheme sanction charge through the ‘good faith’ provisions in the legislation - see PTM135400.

In order to show that a scheme had reasonable grounds for believing that an unauthorised payment was authorised schemes should retain documentary evidence of any member statement or information they have relied on.

Where schemes discover that a payment that they had believed to be authorised is not in fact so, they should report the unauthorised payment on the Event Report - see PTM161100.

Example

For payments made in the past, please read the Scope section at the top of this page.

Catherine is aged 61. She has uncrystallised defined benefits held under three registered pension schemes (scheme A, B and C). Her benefits under each scheme are held in three different arrangements, i.e. A1, A2, A3 etc. Catherine has no other benefits and is not in receipt of any pension in payment. She also has 100% of her lifetime allowance available.

The rules of all three pension schemes allow the commutation of trivial pensions. Catherine wants to commute her benefits as soon as possible. The nominated date her pension benefits must be valued on must fall within a 3 month period ending on the date the first trivial commutation lump sum is paid. Catherine chooses 1 March 2015 as her nominated date and the valuation comes to £29,000. Catherine therefore has the option of commuting her benefits, as her total pension rights are less than the commutation limit of £30,000.

To be a valid valuation, the first trivial commutation lump sum payment must be paid before 1 June 2015 (within 3 months of the valuation). Catherine does not have to take all her benefits as trivial commutation lump sums from each scheme. She may choose to take her benefits under one or two of the schemes and not the other(s). But it must be an all or nothing decision in relation to each scheme, i.e. all the arrangements in a scheme must be paid as a trivial commutation lump sum, or none of them.

Catherine decides to draw all her benefits under schemes A and B as trivial commutation lump sums, i.e. all her rights under arrangements A1, A2 and A3 and B1, B2 and B3. The benefits under scheme A are paid out as a trivial commutation lump sum on 2 May 2015. Her commutation period starts from that date and runs to 1 May 2016. Any payment from scheme B must therefore be paid by that later date, and that payment must represent all her rights under arrangements B1, B2 and B3.

The benefits under scheme B are paid on 5 June 2015 (within the commutation period).

Catherine decides to leave the benefits held under scheme C. She can change her mind and decide to fully commute these benefits up until 1 May 2016. But after this date the chance to commute those benefits as a trivial commutation lump sum is lost.

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Contributions or accrual after the nominated date

For payments made in the past, please read the Scope section at the top of this page.

Any contributions made by or on behalf of the member after the nominated date may not be commuted and paid as a trivial commutation lump sum. This similarly applies to any new rights that have accrued after this date. This is because those contributions or rights represent new pension rights that were not in existence on that nominated date and were not included within the pension rights valuation.

Any increase in the value of any commutable rights (that is, defined benefits or in-payment money-purchase in-house scheme pensions) held on the nominated date may however be included in the payment of the trivial commutation lump sum.

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Taxation

Paragraph 11 Schedule 31 Finance Act 2004

Section 636B Income Tax (Earnings and Pensions) Act 2003

Paragraph 59 Schedule 10 Finance Act 2005

If the member has not previously drawn or become entitled to any other benefits under the registered pension scheme before the trivial commutation lump sum is paid, 75% of the lump sum paid is treated as taxable pension income of the member for the tax year the payment is made, accountable through PAYE.

The 25% deduction is given to reflect that, if the trivial commutation lump sum was not paid and normal benefit rules applied, the member would (generally) be entitled to a tax-free pension commencement lump sum, representing 25% of the capital value of the benefits coming into payment. No extra deduction is given where the member is entitled to a pension commencement lump sum of more than 25% due to the transitional protection of such an entitlement held before 6 April 2006.

Where a pension in payment is being commuted, or the member has previously drawn (or become entitled to) any other benefit from the scheme, but still has uncrystallised rights held in any arrangement under the scheme, 25% of the value of the uncrystallised rights may be paid tax-free. The remaining part of the payment is taxed as pension income for the tax year the lump sum payment is made. Again, this taxable income is accountable through PAYE.

PTM134500 explains how to value uncrystallised rights for these purposes.

Operating PAYE on the payment

Where the lump sum payment is in respect of a pension already in payment, use the PAYE code already in operation.

Where the pension being commuted was not already in payment, use the basic rate (BR) tax code.

Where the recipient is not UK tax resident then use the emergency tax code.

Guidance on how to operate PAYE correctly on these lump sums can be found in CWG2 - Employer’s further guide to PAYE and NICs. Find links to this and other guidance under heading ‘Operating PAYE on the lump sum payment’ at PTM061200.