It is possible to pay small lump sums from an arrangement provided certain criteria are met. This includes such things as payments made as a result of a genuine error but also include some commutation payments, the most important of which are described below.
You will probably be asking yourself 'what does relevant accretion mean?' This typical piece of HMRC-speak refers to unexpected additional benefits that have arisen because of a belated payment received by a scheme or where an individual’s rights are found to be greater than was first thought.
Relevant accretions could be:
The conditions that have to apply before the additional benefits can be paid out as a lump sum are:
Formally known as the de minimis rule for pension schemes, these provisions used to only apply to occupational schemes and public service schemes, but were extended to all registered pension schemes on 6 April 2012.
A lump sum that extinguishes an individual's rights under an occupational scheme or public service scheme can be made if:
* If the scheme is a larger pension scheme, there is no need to include rights under a related scheme. A larger pension scheme is one that has at least 50 members and meets various other conditions.
From 6 April 2012 these rules were extended creating a new authorised payment which covers schemes that are not occupational or public service schemes, for example personal pension plans.
The conditions are as follows:
The conditions are pretty clear but the second last one needs a little more comment.
'The payment extinguishes the individual's entitlement to benefits under the arrangement'. This is important as the rules apply to arrangements and not to schemes. So it would be possible to pay out three small pots held in a provider's personal pension scheme as they are separate arrangements.
A payment made under these rules is not actually a trivial commutation lump sum but it is treated as a trivial payment for taxation purposes. This means that if the payment is made from uncrystallised money, 25% will be tax-free and the rest chargeable to income tax as pension income.
The payment of a small lump sum is not a benefit crystallisation event and as such the funds are not tested against the lifetime allowance.
The Taxation of Pension Schemes (Transitional Provisions) (Amendment) Order 2009 extended the normal trivial commutation provisions. Since 6 April 2015 this only applies to defined benefit schemes. If tax-free cash which had scheme specific protection is paid, the connected pension can be paid as a lump sum if its value is not more than £10,000.
The conditions which apply are:
The following table sets out how the benefits should be valued:
|Type of benefit||Calculation of benefits value|
|Defined benefit scheme (scheme pensions)||Multiply the individual's annual pension before commutation by 20. Where lump sums are provided otherwise than by commutation they are valued using a factor of 1:1 and are added to the above value.|
|Money purchase scheme||The total market value of the funds/assets held, unless a scheme pension is paid, in which case a factor of 20:1 is used.|
|Cash balance plan||The value of the benefits as calculated in line with the scheme rules.|
If the lump sum is being paid from uncrystallised funds the individual can receive up to 25% of the lump sum tax-free. The rest is payable at their marginal rate of income tax. This means that if they currently pay tax at the 20% basic rate tax then 75% of the lump sum will be subject to this tax. It is important to be aware that taking lump sums from the pension in this way could push them into a higher income tax bracket, which could mean they need to pay more tax than they originally thought.
If the lump sum is being paid from crystallised funds the entire payment is taxed at their marginal rate of income tax.
The provider or scheme trustee is required to apply tax at the basic rate regardless of the amount of tax the individual is actually liable for. This means that the amount of tax the provider or scheme trustee deducts may be greater or less than the amount which should apply to the individual. If they think that they have paid too much or not enough tax, then they will need to discuss this with HMRC.
If the lump sum is being paid from uncrystallised money and they would have been entitled to more than 25% of their benefits value as tax-free cash at retirement, the amount that they can take tax-free on payment of the lump sum will still only be 25%. The enhanced entitlement to tax-free cash will be lost. However, as detailed in Lump sum after the payment of a scheme specific lump sum section above it may be possible to take the enhanced tax-free cash sum first then pay the remainder as a small lump sum.
The payment of a small lump sum is not a benefit crystallisation event nor does it trigger the money purchase annual allowance.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.