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Jim Grant
Senior Technical Support Consultant

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Pension compensation payments

Published  03 December 2024
   3 min read

Can you make pension compensation payments into your pension plan and what is the tax position if you do?

Key facts

  • Pension compensation payments received for wrongful advice is usually paid directly to the affected individual.
  • The pension compensation payment can be into a pension plan, but tax relief is subject to the usual relevant UK earning limits and annual allowance.
  • The pension compensation payment may be liable to capital gains tax.

When is a pension compensation payment paid?

Compensation payments are usually for receiving wrongful advice. Normally the compensation is paid directly to the affected individual. But sometimes it’s paid to the scheme administrator. The scheme administrator is more likely to claim it when it’s compensation for investment loss, for example a delay in buying units or someone being put into the wrong fund.

What can an individual do with a pension compensation payment?

Compensation due to the individual can be paid directly to them as a lump sum. Usually, the individual wants to pay it into their pension plan. The only way this can be done is to pay it as a net personal contribution which is grossed up at the basic rate of income tax. The individual can claim any additional tax relief in the normal way. Tax relief is subject to the usual relevant UK earning limits and annual allowance. If the individual doesn't have sufficient earnings to cover the compensation payment on top of any other individual pension contributions, the only remedy is to stagger the contribution over more than one tax year or only pay contributions up to their tax relief.

Compensation due to the pension scheme, for example because of a unit price error being rectified, can be paid directly into the scheme. The scheme administrator will use the money to buy units in the funds the plan is invested in. This means the compensation isn’t regarded as a contribution, so no tax relief is added.

Do you pay tax on a compensation payment?

Any interest element in a payment to the individual will be chargeable to income tax at the individual’s highest rate of tax. But the rest of the compensation is likely to be treated as a capital sum, potentially making it subject to capital gains tax.

However, if the compensation payment is for poor advice, capital gains tax is only payable if the compensation exceeds £500,000 and even then, a claim can be made to HMRC for the amount above the threshold to be exempt.

Further information

Member contributions tax relief and annual allowance

An individual can pay as much as they like into a pension but unfortunately, there's a limit on the amount of tax relief that can be given.

Read more  about Member contributions tax relief and annual allowance

Annual allowance

An annual allowance for pension savings applies each year, which is based on a pension input period. This limits the amount of tax privileges available on pension savings each year.

Read more  about Annual allowance

Disclaimer

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.