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HMRC internal manual

Pensions Tax Manual

Death benefits: lump sums: tax on authorised lump sum death benefits

Glossary PTM000001
   

Types of tax charges on authorised lump sum death benefits
In what circumstances does each charge apply
Special lump sum death benefits charge
Taxable lump sum death benefit payments to a trust - refund of tax to trust beneficiary
Operating PAYE on the recipient’s pension income

For payments of authorised lump sum death benefits made before 6 April 2016, please see the detailed guidance elsewhere in this chapter on each type of lump sum death benefit (PTM073000).

This page also does not cover the taxation of a trivial commutation lump sum death benefit (PTM073700) or a winding-up lump sum death benefit (PTM073800).

Types of tax charges on authorised lump sum death benefits

Section 206 Finance Act 2004

Sections 579A, 636A and 636AA Income Tax (Earnings and Pensions) Act 2003

Payments of charity lump sum death benefits and life cover lump sum death benefits are not taxable.

Other types of authorised lump sum death benefits are tax-free in some circumstances, for example they may be free of income tax for the recipient if the member died before reaching 75, subject in some cases to a further condition that the payment is made within the appropriate two year period.

The detailed guidance in this chapter for each type of authorised lump sum death benefit explains the circumstances in which a payment is tax-free and when it is taxable.

Where the lump sum death benefit is taxable, depending on the type of payment and the recipient, the tax charge is either:

  • income tax as pension income of the recipient or
  • the special lump sum death benefits charge on the scheme administrator.

 

Where the payment of the lump sum death benefit is a BCE, its payment could potentially result in the member’s lifetime allowance being exceeded, and a lifetime allowance charge arising (see PTM071000).

In what circumstances does each charge apply

Where a taxable lump sum death benefit listed below is paid

  • on or after 6 April 2016 and
  • directly from the pension scheme to an individual,

it is usually treated as the recipient’s pension income and tax deducted under PAYE by way of the RTI process.

The taxable lump sum death benefits this tax treatment relates to are:

  • defined benefits lump sum death benefit
  • uncrystallised funds lump sum death benefit
  • pension protection lump sum death benefit
  • annuity protection lump sum death benefit
  • drawdown pension fund lump sum death benefit
  • flexi-access drawdown fund lump sum death benefit.

 

But where the payment is to an individual who is receiving the payment in their capacity as:

  • a trustee (but not a bare trustee)
  • a personal representative
  • a director of a company
  • a partner in a firm, or
  • a member of a  limited liability partnership

the payment is not treated as their income for tax purposes.  Instead, the scheme administrator is liable to the special lump sum death benefits charge (see below) on the amount paid.

Special lump sum death benefits charge

The special lump sum death benefits charge is an income tax charge at a flat rate of 45% (55% if the lump sum was paid before 6 April 2015).  The scheme administrator is responsible for paying this tax charge and will usually deduct the tax before paying the lump sum. The scheme administrator must pay the tax due using the Accounting for Tax (AFT) return procedure. For guidance on when and how to file the Accounting for Tax return see PTM162000.

The lump sum is not treated as income of the recipient for any purpose of the Tax Acts.  The recipient is also not liable for the special lump sum death benefit tax charge, so if they are a non-taxpayer they cannot make any repayment claim in respect of the tax paid.  However, there is an exception where the special lump sum death benefits charge is paid in respect of a payment on or after 6 April 2016 to a trust that is not a bare trust, and that trust later makes a payment, funded by the lump sum death benefit, to a beneficiary of that trust. See Taxable lump sum death benefit payments to a trust - refund of tax to trust beneficiary (below).

Taxable lump sum death benefit payments to a trust - refund of tax to trust beneficiary

Where

  • the special lump sum death benefits charge is charged on a taxable lump sum death benefit payment on or after 6 April 2016 to a trust that is not a bare trust, and
  • the trustee later makes a payment comprised of all or part of that lump sum death benefit to a beneficiary of that trust,

the gross amount is income for income tax purposes of the individual who is the trust beneficiary, but they can set-off the appropriate amount of charge previously paid by the scheme administrator against their own tax due on the payment.  The appropriate amount is the proportion of the tax charge that is attributable to the amount received by the trust beneficiary.  For example, if two beneficiaries each receive 50% of the lump sum death benefit received by the trust, they can each set off against their own income tax liability 50% of the tax charge paid by the scheme administrator.

The individual must account for the gross amount of lump sum death benefit they received from the trust in their Self-Assessment return, or on R40 repayment claim form.  That is the total of the amount paid to them by the trust, and the proportion of the special lump sum death benefits charge attributable to that amount that was withheld by the scheme administrator.  That proportion of the special lump sum death benefits charge is treated as tax previously paid.  The overall effect is that tax on the lump sum death benefit is paid at the individual’s marginal rates, as if they had received the payment from the pension scheme directly.

Both the scheme administrator and the trustee must follow the requirements for provision of information so that the individual understands the amounts to include in their tax return to claim any repayment.  See PTM165100 and PTM165400.

There is no time limit for onward payment of the lump sum death benefit from the trust to the individual.

Operating PAYE on the recipient’s pension income

Where the recipient is liable to the income tax charge, it is treated as the recipient’s pension income and tax deducted under PAYE by way of the RTI process.  The rate of tax is the recipient’s marginal rate of tax for the tax year in which the lump sum is paid. So, if the individual is a basic rate taxpayer, the rate is basic rate and if the individual is a higher rate taxpayer the rate is the higher rate applying to the individual.

The pension payer should use the following PAYE codes:

  • If the recipient has a P45 from a previous source/employment dated on or after 6 April in the current year, the scheme administrator should operate the code on the P45 on a Month 1 basis.
  • If a scheme administrator already makes payments to the recipient and has a tax code for those payments, the tax code should only be used for additional payments if the payments are being made at the same time. If more than one payment in a month is made and the same tax code is operated against each of those payments it could give the benefit of the tax allowances and rate bands twice.
  • For other trivial commutation lump sum death benefits and winding up lump sum death benefits, use the BR code.
  • In all other circumstances, scheme administrators should use the emergency code on a Month 1 basis against the payment and HMRC will issue a tax code to operate against future payments.

Further guidance on how to operate PAYE correctly on these lump sums can be found in CWG2 - Employer’s further guide to PAYE and NICs (GOV.UK).

There is also guidance for pension schemes on how to operate PAYE on the gov.uk website at https://www.gov.uk/paying-a-company-pension-or-annuity-through-your-payroll. This includes guidance on how to operate PAYE on trivial and winding up lump sums.

Where the beneficiary is receiving a lump sum payment that extinguishes the fund, the scheme administrator must issue a P45 which will enable the recipient to claim any tax refund that might be due in-year.

Because of the way PAYE works, using the emergency or BR code on these lump sum payments may mean that the recipient ends up paying too much tax. Where this does happen, the person who has paid too much tax can claim the tax back in-year. Scheme members can find more information on claiming a tax refund on the gov.uk website at https://www.gov.uk/tax-on-pension-death-benefits.

Many of the people affected won’t know that they may have paid too much tax and so are entitled to a tax refund. To help the people affected it would be helpful if the pension payer includes advice on how to claim a refund when issuing the lump sum payment. Some suggested wording that the pension payers could use is shown below. This will also help the payer by reducing the number of enquiries they may get on how the lump sum has been taxed and claiming refunds.

Suggested wording pension payers can use when making the PAYE lump sum payment

“Your form P45 details include the amount of tax deducted from your lump sum death benefit. The tax deducted may not be the right amount due when all of your income for the year is taken into account.

After next 5 April HM Revenue & Customs will check if you have paid the correct amount of tax, and if not they will contact you. But if you think you have paid too much tax you can ask HM Revenue & Customs for a tax refund now - you do not have to wait until 5 April.

To claim a refund you can complete a form online without needing to contact HMRC directly. You should find this easier to do than completing the form manually. The form is available on the gov.uk website at https://www.gov.uk/claim-tax-refund/you-get-a-pension.

If you prefer to complete the form manually, find out which form you need on the above website and then call the Taxes Helpline on 0300 200 3300. It helps if you have your National Insurance number to hand when you call.”