What happens if benefits under a pension scheme, such as the Pension Commencement Lump Sum (PCLS) or regular benefit payments, are put into payment but it later comes to light that payments were unauthorised under the Finance Act 2004?
How could an unauthorised payment happen?
A PCLS unauthorised payment could happen if:
- A lump sum in excess of 25% of the value of the pension pot is paid to the member,
- There is an error in calculating the cost of an annuity and the excess is paid to the member as part of the PCLS.
A regular pension payment will typically be unauthorised if it is an over-payment or mis-payment. These are usually due to a failure in the administration process. In these circumstances the scheme member will generally be subject to a tax charge of 55% of the benefits received. The scheme administrator may also be subject to a sanction charge of between 15% and 40% of the benefits paid out. We look below at how these charges can be mitigated where payments arise out of a genuine error.
The Registered Pension Schemes (Authorised Payments) Regulations 2009
These regulations deal with unauthorised payments made in error. Regulations 13 and 14 deal with regular pensions payments made in error, Regulations 17 and 18 with lump sum payments made in error.
Regulations 13 & 14 – regular payments made in error
The effect of these regulations is that an over-paid or mis-paid pension can be accepted as an authorised payment subject to satisfying stated conditions. These are:
- The payment was intended to represent a payment of a pension permitted by the rules
- The payer believed the recipient was entitled to the payment
- The payer believed that the recipient was entitled to the payment that was made in error.
If the discovery of the error occurred before payment was made, then the payment may still be treated as authorised if:
- The payer took reasonable steps to prevent the payment being made
- The payment was made while the scheme administrator was considering changing the rules of the scheme which would make future, similar payments authorised
- The payment is made while a change under the bullet point above is actually being made.
Regulations 17 & 18 – lump sum payments made in error
Regulation 17 provides that a lump sum payment which exceeds the permitted maximum, and thus becomes unauthorised, can be deemed to be authorised provided that the lump sum only exceeds the maximum because it was calculated by reference to the amount of a relevant pension. The exemption also applies to errors discovered before the payment is paid, provided that the payer takes reasonable steps to prevent payment.
Regulation 18 applies specifically where a money purchase arrangement is used to purchase an annuity, and the lump sum was calculated by reference to the annuity purchase price. If there is an error in calculating this price, the lump sum could be overpaid. Under both Regulation 17 and 18, a lump sum paid in error which satisfies the necessary conditions can be treated as authorised.
The effect of these regulations is that an over-paid or mis-paid regular pension payment of PCLS can be accepted as an authorised payment, and be taxed as pension income in the tax year in which the payments are actually paid. In order for the PCLS to be accepted as an authorised payment and made tax free it must be within the member’s Lifetime Allowance.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.