Winding up lump sums
In certain circumstances it is possible for a member of a registered pension scheme to take all of their benefits as a one-off lump sum using the winding-up lump sum rules.
- Unlike the trivial lump sum payments at retirement, there is no minimum age before the benefits can be commuted.
- The value of other pension rights do not have to be taken into account.
- There are several conditions that must be met before a payment is made.
- Taxed in exactly the same way as trivial lump sums.
If an individual is in an occupational pension scheme that is in the process of winding-up they may commute their benefits under that scheme. Unlike the trivial lump sum payments at retirement, there is no minimum age before the benefits can be commuted, nor does the value of other pension rights have to be taken into account. There are however several conditions that must be met before a payment is made, they are:
- The scheme is winding-up.
- The total of the individual's benefits value under that scheme is not more than £18,000.
- After the lump sum payment the individual has no benefit rights left in that scheme, including any contingent beneficiary's benefits.
- The employer is not making contributions under any other registered pension scheme in respect of the individual, and the employer undertakes not to make any contributions during the period of one year from the date the lump sum is paid. This undertaking must be in writing and confirm the employer will meet these conditions. It should be sent to HMRC.
The definition of employer is somebody who employs the individual at the time the lump sum is paid, and who has made contributions under the pension scheme in respect of them within the period of 5 years ending with the day on which the lump sum is paid.
- The individual must have some lifetime allowance available.
Before the lump sum can be paid the individual must have some of the lifetime allowance left. This is to ensure that scheme members don't use this payment method to avoid the lifetime allowance charge where they have already used up all of their lifetime allowance.
Valuing the benefits
It is only possible for benefits to be taken as a winding-up lump sum if the value of all of the individual's benefits under that scheme is not more than £18,000. Any benefits they have under other pension schemes can be ignored.
In certain circumstances it will not be obvious if their benefits value is not more than £18,000. 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 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.|
How is it taxed?
If the benefits have been crystallised no element of the lump sum will be tax-free. If the benefits are uncrystallised 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 if they currently pay tax at the 20% basic rate tax then the taxable element 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 the member into a higher income tax bracket, which could mean they need to pay more tax than they originally thought.
The 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 the amount of tax the 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 they would have been entitled to more than 25% of their benefits value as tax-free cash at retirement, the amount they can take tax-free on payment of a winding-up lump sum will still only be 25%. The enhanced entitlement to tax-free cash will be lost.
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.