RPSM04101130 - Technical Pages: Taxation: Authorised member payments: Taxation of trivial or, winding up lump sums, commuted equivalent pension benefits and other small lump sum payments
Taxation of trivial or winding up lump sums, commuted equivalent pension benefits and other small lump sum payments
[s636B & 683 ITEPA 2003][The Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171]
The following lump sums are taxable as pension income in the tax year in which the payment is made
- commuted equivalent pension benefits (see page RPSM09105300)
- a trivial commutation lump sum (see RPSM09104900),
- a winding up lump sum (see RPSM09105100), or
- certain other small lump sum payments (RPSM09105490)
The person liable to tax is the scheme member receiving the payment.
The amount of tax due depends on whether or not the member has drawn or was entitled to any benefits from the registered pension scheme before the lump sum was paid.
If the member has not taken or was not entitled to any benefits from the scheme before payment of the lump sum the taxable amount is 75% of the amount of the lump sum payment.
If before the lump sum is paid the member has taken benefits, or was entitled to the payment of benefits, from the scheme but also had other uncrystallised rights in the scheme, the taxable amount is the amount of the lump sum paid less 25% of the value of the uncrystallised benefit rights. The uncrystallised rights must be determined in accordance with s212 FA 2004. RPSM04104670 explains how uncrystallised rights are valued for the purposes of s212 FA 2004.
If the member has no uncrystallised rights in the scheme before the lump sum is paid, the taxable amount is the total amount of the lump sum payment.
Tom receives a trivial commutation lump sum of £10,000. This lump sum includes uncrystallised rights, which are valued at £5,000.
The member’s taxable pension income in respect of the lump sum payment is
£10,000 - (£5,000 x 25%) = £8,750.
As the payments are taxable as pension income the rate of tax is the member’s marginal rate of tax for the tax year in which the lump sum is paid. So if the member is a basic rate taxpayer, the rate is 20%, if a higher rate taxpayer the rate is 40% and so on.
PAYE applies to these lump sum payments. The payer of the lump sum must operate PAYE on the taxable amount of the lump sum payment in accordance with the PAYE rules before paying the lump sum.
Operating PAYE on the lump sum payment
Where the lump sum payment is in respect of a pension already in payment, use the PAYE code already in operation. Where the member’s pension has not yet been paid and the scheme does not have a PAYE code for the recipient an emergency code applies.
Guidance on how to operate PAYE correctly on these lump sums can be found in CWG2 - Employer’s further guide to PAYE and NICs. A copy of the CWG2 can be found on the HMRC website. To find it on the HMRC website either use the ‘find a form’ function or type CWG2 into the ‘search’ box at the top of the HMRC webpage.
There is also guidance for pension schemes on how to operate PAYE on the HMRC website at http://www.hmrc.gov.uk/paye/payroll/pensions/. This includes guidance on how to operate PAYE on trivial and winding up lump sums.
Because of the way PAYE works on these lump sum payments often the member ends up paying too much tax. Where this happens, the member can claim the tax back in year. There is guidance for individuals on how to do this on the HMRC website at http://www.hmrc.gov.uk/incometax/overpaid-thro-pension.htm. The problem is that 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 please include advice on how to claim a refund when you issue the lump sum payment. There is some suggested wording that you could use shown below. This will also help you by reducing the number of enquiries you may get on how the lump sum has been taxed and claiming refunds.
Suggested wording pension payers can use when making the lump sum payment
Your form P45 details include the amount of tax deducted from your pension commutation lump sum. 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 call your usual Revenue & Customs office and ask for form P53. You can find the numbers on the ‘contact us’ pages of the HMRC website at www.hmrc.gov.uk/, or alternatively, in the phone book under HM Revenue & Customs.
It helps if you have your National Insurance number to hand when you call.