HMRC internal manual

Pensions Tax Manual

PTM073300 - Death benefits: lump sums: pension protection lump sum death benefit

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Paying a pension protection lump sum death benefit
Conditions for paying a pension protection lump sum death benefit
When and to whom a pension protection lump sum death benefit can be paid
The maximum pension protection lump sum death benefit payable
A pension protection lump sum death benefit and the lifetime allowance
How a pension protection lump sum death benefit is taxed

Paying a pension protection lump sum death benefit

Where a member starts getting a scheme pension from a defined benefits arrangement they can choose to guarantee that a set amount of pension will be provided. If the member dies before the guaranteed amount of pension has been paid, the balance can be paid as a pension protection lump sum death benefit.

Conditions for paying a pension protection lump sum death benefit

Paragraph 14 Schedule 29 Finance Act 2004

For a lump sum to be a pension protection lump sum death benefit it must satisfy all the following payment conditions. The payment conditions are:

  • it is paid in respect of a defined benefits arrangement,
  • it is paid in respect of a scheme pension to which the member was entitled at the date of the member’s death,
  • the member has specified that it is to be treated as a pension protection lump sum death benefit rather than a defined benefits lump sum death benefit (see PTM073100), and
  • the amount of the payment is not more than the ‘pension protection limit’ – see The maximum pension protection lump sum death benefit payable.

If the amount of the lump sum is more than the ‘pension protection limit’, the excess amount is not a pension protection lump sum death benefit. If the excess cannot be paid as some other type of lump sum death benefit it will be an unauthorised member payment and taxed accordingly (see PTM131000). The amount of the lump sum up to the pension protection limit will be a pension protection lump sum death benefit.

These are the payment conditions for lump sums paid in respect of someone who died on or after 6 April 2011. For guidance relating to payments made in respect of a member who died before 6 April 2011 see RPSM10105150 on the National Archives.

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When and to whom a pension protection lump sum death benefit can be paid

Where the member died on or after 6 April 2011, a pension protection lump sum death benefit can be paid whatever age the member was when they died. The pensions tax rules do not set any conditions on who can be paid this type of lump sum or any time limit for its payment. However the member’s pension scheme may have their own rules in respect of this payment.

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The maximum pension protection lump sum death benefit payable

Paragraph 14 Schedule 29 Finance Act 2004

Article 33 Taxation of Pensions (Transitional Provisions) Regulations 2006 - SI 2006/572

The ‘pension protection limit’ is the maximum amount that can be paid as a pension protection lump sum death benefit.

Broadly the maximum pension protection lump sum death benefit that can be paid is the crystallised amount of the scheme pension for lifetime allowance purposes less the amount of scheme pension paid to the member. The “pension protection limit” is calculated using the formula

AC - AP - TPLS

Where:

AC is either

  • the amount which crystallised as a BCE 2 (see PTM088620) as the member became entitled to their pension before reaching age 75, or
  • the amount that would have crystallised as a BCE 2 but for the fact that the member became entitled to their scheme pension on or after reaching age 75.

AP is the amount of the scheme pension paid up to the time the member died. If the scheme pension started before 6 April 2006 only those pension payments made on or after 6 April 2006 are included.

TPLS is the amount of any pension protection lump sum death benefit previously paid in relation to the member’s scheme pension entitlement either under the scheme or by any insurance company with which that entitlement had been secured.

Example

John becomes entitled to a scheme pension of £10,000 per annum under a defined benefits arrangement. John’s scheme administrator secures half the scheme pension liability by purchasing an annuity with pension protection from an insurance company. John specifies that any lump sum death benefit will be paid as a pension protection lump sum death benefit as opposed to a defined benefits lump sum death benefit.

For lifetime allowance purposes the amount crystallised (AC) is £200,000. So £200,000 is the maximum pension protection that can be provided under the scheme (or through any annuity contract secured by the scheme administrator).

John dies aged 74 having received total scheme pension payments (AP) of £100,000. The maximum pension protection lump sum death benefit that can be paid on his death is £100,000. This limit is calculated as follows:

  • AC - AP - TPLS, or
  • £200,000 (AC) - £100,000 (AP) - £0 (TPLS) = £100,000.

But if £50,000 was paid as a pension protection lump sum death benefit by the insurance company (in relation to the annuity contract securing part of the scheme pension entitlement), a further £50,000 could be paid direct from the scheme under the arrangement the pension entitlement arose from. The limit is calculated as follows:

  • AC - AP - TPLS, or
  • £200,000 (AC) - £100,000 (AP) - £50,000 (TPLS) = £50,000.

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A pension protection lump sum death benefit and the lifetime allowance

A pension protection lump sum death benefit is not a benefit crystallisation event so its payment does not trigger a lifetime allowance test. it does not use up any of the deceased member’s or the recipient’s lifetime allowance.

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How a pension protection lump sum death benefit is taxed

The tax treatment of the lump sum depends on when it was paid.

Death benefit paid before 6 April 2015

Section 206 Finance Act 2004

Sections 636A(4)(a) Income Tax (Earnings and Pensions) Act 2003

The Pension Benefits (Insurance Company Liable as Scheme Administrator) Regulations 2006 - SI 2006/136

Lump sums paid before 6 April 2015 are subject to the special lump sum death benefits charge. The rate of that tax charge was 55 per cent (35 per cent for payments made before 6 April 2011).

Where the lump sum was paid by the scheme the person liable to pay the tax is the scheme administrator.

Where the lump sum was paid by an insurance company, that insurance company is liable to pay the tax charge as if they were the scheme administrator.

The tax charge should be reported and paid using the Accounting for Tax return – see PTM162000.

Death benefit paid between 6 April 2015 and 5 April 2016

Section 206 Finance Act 2004

Sections 636A(4)(a) Income Tax (Earnings and Pensions) Act 2003

The Pension Benefits (Insurance Company Liable as Scheme Administrator) Regulations 2006 - SI 2006/136

The tax treatment of pension protection lump sum death benefits paid after 5 April 2015 but before 6 April 2016 depends on how old the member was when they died.

If the member was aged under 75 when they died the lump sum is not taxable.

If the member was aged 75 or older when they died the lump sum is subject to the special lump sum death benefits charge. The rate of that tax charge during this period was 45 per cent.

The scheme administrator is liable to pay the tax charge where the lump sum was paid from the scheme. Where the lump sum was paid by an insurance company, that insurance company is liable to pay the tax charge as if they were the scheme administrator.

The tax charge should be reported and paid using the Accounting for Tax return – see PTM162000.

Death benefit paid on or after 6 April 2016

Section 206 Finance Act 2004

Sections 636A(4) and (4ZA) and 636AA(2) Income Tax (Earnings and Pensions) Act 2003

The Pension Benefits (Insurance Company Liable as Scheme Administrator) Regulations 2006 - SI 2006/136

The tax treatment of pension protection lump sum death benefits paid on or after 6 April 2016 depends on how old the member was when they died, and who receives the payment.

If the member was aged under 75 when they died the lump sum is not taxable.

The lump sum death benefit is taxable if the member was aged 75 or older when they died. Whether the taxable lump sum payment is:

  • taxable as income of the recipient, or
  • subject to the special lump sum death benefits charge

depends on whether or not the lump sum is paid to a ‘non-qualifying person’. Payments to a ‘non-qualifying person’ are subject to the special lump sum death benefits charge.

Go to PTM073010 for more detailed information on the tax treatment of lump sum death benefits paid on or after 6 April 2016, including the definition of a ‘non-qualifying person’.