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HMRC internal manual

Pensions Tax Manual

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Member benefits: lump sums: winding-up lump sum

Glossary PTM000001
   

Payment of a winding-up lump sum
Commutation of pensions in payment and any contingent beneficiary’s pension entitlement as part of the winding-up lump sum
Level of winding-up lump sum that may be paid
Taxation
Reporting scheme wind-up to HMRC
Winding up a scheme simply to facilitate payment of winding-up lump sum

Payment of a winding-up lump sum

Paragraph 10 Schedule 29 Finance Act 2004

Where an occupational pension scheme is being wound up and the member’s benefit rights are commuted to a lump sum that payment may qualify for tax treatment as a winding-up lump sum provided the conditions set out below are satisfied. There is no lower age limit for payment of a winding-up lump sum. The conditions that the lump sum must satisfy in order to qualify for tax treatment as a winding-up lump sum are that the lump sum:

  • does not exceed the maximum (see below)
  • is paid only where the member has available lifetime allowance (see below), and
  • extinguishes the member’s entitlement to benefits under the scheme (this means that any contingent pension on death must also be extinguished by the lump sum payment, as this entitlement forms part of the member’s rights in the scheme).

In addition, any employer of the member at the time the lump sum is paid who has made contributions under that scheme in the last five years in respect of the member who is to receive the winding-up lump sum:

  • is not making contributions under any other registered pension scheme in respect of the member, and
  • undertakes to HMRC not to make such contributions during the period of 1 year from the date the lump sum is paid.

The undertaking above should be in writing (there is no stock form for this) and confirm that the employer will meet the condition in paragraph 10(3)(c) of Schedule 29 to Finance Act 2004. It should be sent to HMRC at the following address before the winding-up lump sum is paid. One declaration per employer listing all the members in respect of whom they give the undertaking at that time is sufficient.

Pension Schemes Services
HM Revenue & Customs
Fitz Roy House
Castle Meadow Road
Nottingham
NG2 1BD

What is meant by employer

The contributions and undertaking rules set out above relate only to a current employer of the member who has, in the five years before the lump sum payment, made contributions in respect of the member to the scheme which is being wound up (whether or not the employer is still participating in the scheme). So if a member has a current employer who has never contributed to the scheme which is being wound up, then there is no need for that employer to give such an undertaking.

Employers who have contributed to other pension schemes but not to the pension scheme winding up are outside the definition of employer for this purpose, even if benefits under those other schemes have transferred across into the scheme that is winding up. As long as they have never contributed to the scheme which is winding up, they do not have to supply an undertaking.

Partial winding-up

A scheme may have several non-related employers participating in it on an industry-wide basis. Where an employer ceases to participate and leaves the scheme securing all the member’s rights from that employment outside the scheme, e.g. by transfer or annuity purchase, such a partial winding-up will constitute a scheme winding-up for the purposes of these provisions subject to all of the following circumstances being met:

  • there is a registered pension scheme which is an occupational pension scheme,
  • the occupational pension scheme comprises a number of different sections,
  • the scheme rules provide for individual sections to be wound up,
  • each section operates in respect of a particular employer participating in the scheme,
  • if an employer has more than one section under a pension scheme all the sections relating to that employer must be wound up
  • the winding-up means that the employer’s entire participation in the scheme ceases.

Lifetime allowance

The payment of a winding-up lump sum is not within the scope of BCE 6 and so does not trigger a lifetime allowance test, although as mentioned above, the member must have some lifetime allowance remaining at the time of payment for it to be treated as a winding-up lump sum.

Where the lump sum is being paid after age 75 from uncrystallised rights or funds, those rights or funds will have been tested against the member’s lifetime allowance under BCE 5 or BCE 5B as appropriate 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, the fact that a BCE 5 or 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, solely for the purposes of calculating whether the member has available lifetime allowance, those events are treated as though they were BCEs, thus reducing the amount of lifetime allowance available at the time of the lump sum on scheme wind-up.

Maximum that can be paid as a winding-up lump sum

Paragraph 10(2) Schedule 29 Finance Act 2004

The maximum amount that can be treated as a winding up lump sum is £18,000.

This limit applies on a scheme by scheme basis. Benefits held in other schemes, either crystallised or still accruing, do not need to be aggregated with the payment being made from the scheme that is winding up.

Where a payment is made which exceeds this limit, the excess will not be a winding-up lump sum. Assuming the excess payment is not any other authorised member payment (including a lifetime allowance excess lump sum - PTM084000), it will be an unauthorised member payment (see PTM132000).

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Commutation of pensions in payment and any contingent beneficiary’s pension entitlement as part of the winding-up lump sum

Pensions in payment

Pensions in payment may be commuted into a winding-up lump sum. And any pension already in payment must be commuted if any uncrystallised entitlements held by the member under the same scheme are to be payable as a winding-up lump sum. This is because the winding-up lump sum must extinguish the member’s entitlement to benefits under the scheme.

Contingent beneficiary’s benefits

Where specifically identifiable contingent beneficiary’s benefits/rights exist, these must be extinguished along with the member’s own entitlement to benefits, and paid to the member as part of the winding-up lump sum payment.

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Level of winding-up lump sum that may be paid

Under a money purchase arrangement, this will be the value of the sums and assets held in that arrangement.

Under a defined benefits arrangement, it is for the scheme to attribute a capital value to the pension benefit entitlement being commuted for the purposes of deciding the size of the payment to be made.

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Taxation

Paragraph 11 Schedule 31 Finance Act 2004

Paragraph 59 Schedule 10 Finance Act 2005

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

If the member has not previously drawn (or become entitled to) any other benefits under the registered pension scheme before the winding-up 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% tax-free element reflects that if the winding-up 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 up to 25% of the capital value of the benefits coming into payment. 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, they are still taxed on 75% of the winding-up lump sum.

Where the only rights under the registered pension scheme that are commuted represent a pension in payment, all of the winding-up lump sum is treated as taxable pension income of the member for the tax year the lump sum payment is made. This taxable income is accountable through PAYE.

Where the rights under the registered pension scheme represent both a pension in payment (or any other rights the member has become entitled to or a mixture of both) and uncrystallised rights in respect of the member, 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 - see PTM024600.

PTM135000 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

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.

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Reporting scheme wind-up to HMRC

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

Regulation 4 The Registered Pension Schemes (Provision of Information) Regulations 2006 - SI 2006/567

Where a registered pension scheme winds up, the scheme administrator is required to provide HMRC with confirmation of the date the scheme was wound up. They must do this within 3 months of the wind-up date. This requirement is explained in more detail in PTM161100.

Section 98 Taxes Management Act 1970

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

The registered pension scheme return

Section 250(8) Finance Act 2004

Where a scheme is winding up, the deadline for submission of the registered pension scheme return is also different - see PTM163000.

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Winding up a scheme simply to facilitate payment of winding-up lump sum

Section 265 Finance Act 2004

Where the winding-up of a registered pension scheme has begun, and HMRC consider that the scheme is being wound up wholly or mainly for the purpose of facilitating payment of one or more winding-up lump sum(s) (or before 6 April 2015, winding-up lump sum death benefit(s)), the scheme administrator will become liable to a penalty of up to £3,000 in respect of each member or recipient paid such a lump sum by the scheme.