If a member is in an occupational pension scheme that is in the process of winding-up the member 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:
Before the lump sum can be paid the member 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 the member has already used up all of their lifetime allowance.
It is only possible for benefits to be taken as a winding-up lump sum if the value of all of the member's benefits under that scheme is not more than £18,000. Any benefits the member has under other pension schemes can be ignored.
In certain circumstances it will not be obvious if a member's 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 member'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 benefits have been crystallised no element of the lump sum will be tax-free. If the benefits are uncrystallised the member can receive up to 25% of the lump sum tax-free. The rest is payable at the member's 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 member 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 member. If the member thinks that they have paid too much or not enough tax then they will need to discuss this with HMRC.
If the member 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.