Pensions Technical factsheet July 2014

Transcription

1 Pensions Technical factsheet July 2014 For financial advisers only Small Lump Sum Payments This communication is for financial advisers only. It mustn t be distributed to, or relied on by, customers. This factsheet is based on our understanding of current and draft legislation, which may change. Background When can a payment after a relevant accretion be treated as a small lump sum? When can a compensation payment under the FSCS be treated as a small lump sum? When can payments to members receiving secured pensions be treated as a small lump sum? What is the deminimis rule for non-occupational or non-public service pension schemes? What is the deminimis rule for occupational or public service pension schemes? When do payments by larger occupational or public service schemes become small lump sums? When can a small lump sum be paid in connection with ordinary tax-free cash protection? How are small lump sums taxed?

2 Background It is possible for a trivial commutation lump sum payment to be paid to a member where the total value of their pension benefits (including those in payment) across all registered pension schemes they are a member of, is not more than the trivial commutation limit. This limit is set at 30,000 for commutation periods starting on or after 27 March Triviality payments of up to 18,000 (these limits did not change from 27 March 2014) are also allowed in certain circumstances when a scheme is winding up (a winding up lump sum) and for a dependant s pension (a trivial commutation lump sum death benefit). Our Triviality factsheet provides details of these triviality payments. This factsheet can be found on our Technical Zone here. It s common for members to have funds built up in registered pension schemes which are too small to provide a pension but which can t be taken under the triviality rules as the scheme is not winding up or their total pension benefits are over the trivial commutation limit. To try to alleviate some of the problems with these cases, HM Revenue & Customs (HMRC) issued regulations introducing further commutation provisions. This factsheet provides a summary of these commutation payments, which HMRC refer to as small lump sums. Most of these small lump sums allow payments of up to 10,000 to be made from 27 March Previously small lump sum payments were restricted to 2,000. The only exception to this is for members receiving secured pensions who take small lump sums (as detailed here) as the limit is based on the new trivial commutation limit of 30,000 for commutation periods starting on or after 27 March Note that the legislation does not require registered pension schemes to offer the payment of small lump sums. The rules of each scheme will determine whether or not small lump sums can be paid. When can a payment after a relevant accretion be treated as a small lump sum? It s not uncommon for scheme administrators to find themselves holding small amounts of money for members who have either taken their benefits or transferred their funds to another scheme. If a small amount comes about as a result of a relevant accretion, the scheme administrator may be able to pay it to the member as an authorised payment, if the scheme rules allow. A relevant accretion can only occur after one of the following events, in respect of a member: A transfer from a registered pension scheme to another registered pension scheme or to a qualifying recognised overseas pension scheme, or The purchase by the scheme of a scheme pension or lifetime annuity from an insurance company. Where the purchase was made on or after 6 April 2006, the member must have had some or all of their lifetime allowance remaining at that time. In determining whether some or all of the member s lifetime allowance is available, the fact that benefit crystallisation event 5 (reaching age 75 under an uncrystallised defined benefit arrangement) or 5B (reaching age 75 with uncrystallised funds under a money purchase arrangement) may have taken place is ignored. A relevant accretion is defined as: a payment to the original scheme in respect of the member which is not a contribution (note that contracted-out contributions are not treated as contributions) a recognised transfer (a transfer in from another registered pension scheme) a transfer in from any other pension scheme, or

3 an increase in the value of the member s arrangement which exceeds the value the scheme administrator had believed they had, and/or a benefit the scheme administrator becomes aware that the member is entitled to after the transfer or annuity purchase has been made (and could not reasonably have been expected to be aware of before the transfer/purchase). Examples of relevant accretion 1. Contracted-out contributions received after the member had transferred his pension benefits out to another registered pension scheme. 2. An unexpected investment return, for example a dividend payment, received after the member had purchased a lifetime annuity. A payment made to the member after a relevant accretion will qualify as a small lump sum provided that the payment: extinguishes the member s entitlement to benefits under the pension scheme (but where a scheme pension or lifetime annuity was purchased, the scheme pension or annuity is ignored when determining whether the member s entitlement to benefits under the scheme have been extinguished) does not exceed either 10,000 or the value of the relevant accretion is paid within six months of the accretion The payment can be made to the member or in respect of the member, if the member has died. When can a compensation payment under the FSCS be treated as a small lump sum? The Financial Services Compensation Scheme (FSCS) is a statutory fund that aims to compensate policyholders if a financial services firm becomes unable or unlikely to be able to pay claims against it. Generally, this would be where a firm has ceased trading and has insufficient assets to meet claims, or goes into liquidation. A compensation payment made under the FSCS can be paid as an authorised lump sum if: the payment does not exceed 10,000 it extinguishes the member s entitlement to benefits under the registered pension scheme The payment doesn t actually have to be made by the pension scheme itself i.e. it can be made directly by the FSCS. The payment can be made either to the member or in respect of the member if the member has died. When can payments to members receiving secured pensions be treated as a small lump sum? One of the conditions of a trivial commutation lump sum is that the payment of the lump sum must extinguish all benefits under a scheme. This can stop a trivial commutation lump sum being paid from a scheme where a member has both a secured pension (scheme pension or lifetime annuity) in payment and uncrystallised funds, even if the value of all benefits is below the trivial commutation limit. This is because some providers do not allow secured pensions in payment to be commuted. To help avoid this, it may be possible to commute the uncrystallised funds for a small lump sum even though the secured pension would continue to be paid. This can happen in the following circumstances: if the member is also a member of at least one other registered pension scheme, then: a trivial commutation payment has been or is going to be paid in respect of at least one of the other schemes, and the small lump sum payment is made before the end of the commutation period,

4 or if the member is not a member of any other registered pension scheme, then: the member had not previously received either a trivial commutation lump sum or a small lump sum payment under this provision, and the value of the member s total pension rights (including crystallised funds) immediately before the payment does not exceed the trivial commutation limit Where the member is a member of more than one scheme, the lump sum from the scheme with the continuing annuity is a small lump sum and not part of the trivial commutation lump sum that is being paid out. The conditions under which a trivial commutation lump sum can be taken are detailed in our factsheet on Triviality here. Examples: 1. Edward is aged 60 and, under the same money purchase occupational pension scheme, has a scheme pension and uncrystallised funds of 6,000. He has no other pension benefits. The value of his crystallised scheme pension is 16,000 so, combined with the uncrystallised funds of 6,000, his total benefit value in the scheme is under the current trivial commutation limit of 30,000. As the scheme rules don t allow commutation of scheme pensions, Edward can t take a trivial commutation lump sum from the scheme. However, he can take the uncrystallised fund of 6,000 as a small lump sum from the scheme. 2. Assume Edward also has an uncrystallised personal pension fund of 4,000. His total benefits are still under the trivial commutation limit. occupational pension scheme as a trivial commutation lump sum, as some of the benefits under that scheme are already crystallised and can t be commuted. However, the uncrystallised funds of 6,000 can be taken as a small lump sum provided they are taken before the commutation period ends. What is the de minimis rule for nonoccupational or non-public service pension schemes If a member of a pension scheme that is not an occupational or public service pension scheme has a small fund, it is possible to take the benefits as an authorised lump sum payment. The conditions that need to be met are: the member has reached the age of 60 the payment doesn t exceed 10,000 the arrangement the member has not previously received more than two such payments. (This changed from 27 March previously this was just one.) This means the member can have a total of three of these de minimis payments under non-occupational or non-public service schemes) As the rule is applied at arrangement level and not scheme level, the three de minimis payments could be from three different arrangements under the same registered pension scheme or from three different arrangements under different registered pension schemes. This provision applies to arrangements under personal pension schemes, and to arrangements under deferred annuity contracts (such as S32 policies) and retirement annuity contracts (known as s.226 policies). He takes the 4,000 as a trivial commutation lump sum on 1 June 2014, which starts the 12-month commutation period. He can t take the uncrystallised funds under his money purchase

5 What is the de minimis rule for occupational or public service pension schemes? It will sometimes be the case that a member s fund will only buy a very small pension but the criteria which would allow the fund to be paid as a trivial commutation lump sum are not met. The legislation allows a small lump sum payment to be made from an occupational or public service pension scheme when the payment does not exceed 10,000, for payments made on or after 27 March 2014, subject to the following conditions: When do payments by larger occupational or public service pension schemes become small lump sums? In relation to larger occupational or public service pension schemes, there is a further de minimis concession similar to that described in the previous section. It allows a small lump sum to be paid even if the member has benefits in another scheme for the same employment. The following conditions must be met: the member has reached the age of 60 the member is neither a controlling director of a sponsoring employer of this or of any related scheme nor connected to such a controlling director the commutation value of the benefits to which the member is entitled under this and any related scheme is not more than 10,000 for payments made on or after 27 March 2014 (this means that if someone is a member of two or more occupational or public service schemes which are registered pension schemes and relate to the same employment, their total benefit value across all such schemes must be no more than 10,000). the paying scheme no recognised transfer has been made out of this or any related scheme in respect of the member during the three years preceding the date of the payment The commutation value is equal to the amount of the lump sum paid - this is the actual value paid out as opposed to the 20:1 valuation factor used for final salary benefits being tested against the lifetime allowance. there are at least 50 members in the scheme the member has reached the age of 60 the member is neither a controlling director of a sponsoring employer of this or of any related scheme nor connected to such a controlling director the payment does not exceed 10,000 the paying scheme no transfer in from any other pension scheme (whether a registered pension scheme or not) was made into the scheme in relation to the member during the five years preceding the date of the payment, except where the transfer was an acceptable transfer (as described below), and no recognised transfer to a registered pension scheme or qualifying recognised overseas pension scheme was made out of this scheme in respect of the member during the three years preceding the date of the payment and at least one of the following applies: The payment can be made either to the member or in respect of the member, if the member has died.

6 the scheme was in existence on 1 July 2008 the payment is in respect of a defined benefits arrangement and the value of the defined benefits is more than half of the value of the total benefits under the scheme (i.e. the scheme is mostly funded as a defined benefit scheme) there are at least 20 members whose benefit value is more than 10,000 An acceptable transfer is a full or partial transfer from a defined benefit or cash balance arrangement to a defined benefit or cash balance arrangement under the scheme making the small lump sum payment, provided that: where the transfer is being made in connection with the winding up of the original pension scheme containing the defined benefit or cash balance arrangement, the receiving defined benefit or cash balance arrangement relates to the same employment, or the transfer is being made in connection with a relevant business transfer (briefly, a transfer of all or part of a business where, if both parties to the business transfer were companies, they would not be treated as members of the same group), or the transfer is being made as part of a retirement-benefits activities compliance exercise (briefly, this is where a transfer is being made so that the scheme complies with section 255 Pensions Act 2004, or the Northern Ireland equivalent, which is the requirement that members whose rights consist only of prospective death benefits need to be removed from the scheme). The small lump sum payment can be made either to the member or in respect of the member, if the member has died. When can a small lump sum be paid in connection with ordinary tax-free cash protection? If a member has ordinary tax-free cash protection and after taking that cash (which must be more than 25%) the remaining pension would have a commuted value of 10,000 or less, an authorised lump sum can be paid so long as the following conditions are met: the member has reached the age of 60; the payment doesn t exceed 10,000; the member has available lifetime allowance when the payment is made; the arrangement (excluding any pension that was in payment before 6 April 2006) and the lump sum is paid in connection with a protected taxfree cash payment of more than 25% the lump sum is paid no later than one month after the tax-free cash since the tax-free cash was paid: no contribution in respect of the member has been made into the scheme no recognised transfer in respect of the member has been made into or out of the scheme, and the sums and assets held by the scheme for the member have not been used to buy an annuity or scheme pension Note that this type of lump sum is not affected by the 12 month commutation period (as in the case of trivial commutation lump sums). The rules for this type of authorised lump sum payment can be applied independently to any scheme under which a member has scheme-specific tax-free cash. How are small lump sums taxed? Small lump sums are one-off authorised payments and are taxed in the same way as trivial commutation lump sums. This means that if the member has not taken (or become entitled to) any benefits under the registered pension scheme before the small lump sum is paid, 25% of the lump sum will be paid tax free and the balance will be taxed as earned income in the tax year the payment is made. Where a member has taken (or become entitled to) any benefits under the registered pension scheme, only 25% of any uncrystallised funds will be paid tax free with the balance being taxed as earned income in the tax year the payment is made.

7 Where scheme-specific tax-free cash has been taken and the remaining fund is commuted, the whole of the commuted fund will be liable to tax (in other words, after taking the tax-free cash, the member is assumed to only have vested benefits under the scheme). Where a pension in payment is being commuted, the whole of the lump sum will be taxed as earned income in the tax year the payment was made. When the small lump sum is paid to someone who is not the member, i.e. where the member has died, the lump sum will be taxed on the recipient as income in the tax year in which the payment is made. Operating PAYE on the payments: Since 6 April 2013, a scheme administrator will deduct PAYE tax at basic rate (currently 20%) to the taxable part of a lump sum. The amount of tax the member (or the recipient, where the member has died) pays in a tax year will depend on their total taxable income for the tax year. In practice, this means a basic rate taxpayer or non-taxpayer could pay too much tax and a higher or additional rate taxpayer may need to pay more tax through self assessment, as the tax on the lump sum will only have been deducted at 20%. If too much tax is paid, the recipient can claim it back and there is guidance on how to do this here. This factsheet has been produced by Pensions Technical Services [email protected] Aegon is a brand name of Scottish Equitable plc, registered office: Edinburgh Park, Edinburgh EH12 9SE. Registered in Scotland (No ). Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. FCA register number An Aegon company Aegon UK plc C /14