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Technical: When and how can clients best access pension lump sums

20 March 2019

John Keenan, head of Corporate Development, Xafinity SIPP & SSAS, examines the rules that apply to pension lump sums and how they can be accessed efficiently by clients.

The breadth of pensions’ subject matter, especially within SIPP and SSAS, is vast, meaning it can be easily forgotten that at the heart of any pension arrangement is retirement. For many members a tax-free payment or ‘lump sum’ is one of the key incentives in saving for retirement.

The most common type of retirement lump sum available when a member becomes entitled to their pension benefits is the 25% Tax Free Lump Sum. To become entitled the member must have reached age 55, although anyone with a protected pension age or who meets the ill health conditions may be able to receive the sum earlier and be entitled to a relevant pension. Pension options include: drawdown, lifetime or fixed term annuity, and scheme pension. In most cases, members are entitled to a tax-free portion of their pension benefits, referred to as the pension commencement lump sum (PCLS), usually representing 25% of the amount of benefits coming in to payment. Key points to note with a PCLS are:

  • With money purchase arrangements, for every £1 of PCLS to be taken £3 of relevant pension is needed – this equates to 25% tax free cash.
  • Where members have pre A-Day protected benefits they may be able to receive greater than 25% PCLS.
  • The PCLS can be paid up to 6 months before or 12 months after becoming entitled to the pension. For SIPP or SSAS the date of becoming entitled will usually be the benefit crystallisation date.
  • The member must have available lifetime allowance (LTA) for a PCLS to be paid.
  • PCLS can only be paid from uncrystallised funds.

Uncrystallised Lump Sums

On 6 April 2015, alongside pension freedoms, uncrystallised funds pension lump sum (UFPLS) was introduced. This lump sum benefit can be paid from any money purchase arrangement, where 25% of each payment is paid tax-free and the remaining 75% is taxed as pension income, in the same way as a PCLS payment being taken along with a pension option. Other than the value of the member’s pension pot, there is no limit to the amount of UFPLS that can be paid, but members must have lifetime allowance available. Key points to note with a UFPLS are:

  • Members with enhanced or primary protection, that include protection for lump sum rights exceeding £375,000 on 5th April 2006, will be unable to take a UFPLS.
  • UFPLS cannot be paid where a member has an LTA enhancement and either no available LTA or LTA of less than 25% of the intended UFPLS.
  • UFPLS can only be paid from uncrystallised funds.
  • Cannot be taken prior to age 55.

Other points to note with pension ‘lump sum’ payments are:

  • If a member has received a pension credit from their ex-spouse or former civil partner that came from a pension already in payment, then these benefits cannot be included when calculating the PCLS or paid as part of a UFPLS
  • If members want to take lump sums, or income payments, from a SIPP or SSAS there must be sufficient liquidity in the scheme. Many SIPP or SSAS invest in illiquid assets, such as commercial property, therefore some thought must be given on how to manage the assets to meet the lump sum and income needs of members.

As well as the more well-known PCLS and UFPLS, there are less common lump sums that may be payable to members under SIPP and SSAS arrangements.These are as follows.

Serious ill-health lump sum

This allowspension schememembers who are expected to live for less than 1 year to take the entirety of their pension benefits as a lump sum, subject to the following terms:

  • Written evidence from a registered medical practitioner is supplied confirming the member’s life expectancy.
  • The member has not used up all their LTA at the payment date.
  • The payment must extinguish all the uncrystallised rights under the arrangement (and cannot be paid from funds that are in pension).
  • Payment before reaching age 75 is tax free if there is available LTA; any amount being made in excess of the LTA remaining is taxed at 55%.
  • Payment after reaching age 75 is taxed as income at the member’s marginal rate where there is available LTA.

Small pension pot

This allows pension scheme members to take a lump sum if their occupational pension benefit is less than £10,000.SSAS arrangements may often find this difficult due to the member needing to be at arm’s length from any sponsoring employer of the scheme making the payment.

Small pension pots of up to £10,000 can also be taken from schemes that are non-occupational, including SIPP’s. This can be done up to a maximum of three small pension pots.

The lump sum can be taken from crystallised or uncrystallised funds, as long as all rights are extinguished on payment. But there is no requirement to have available LTA, as these payments are not tested against the limit.

Winding-up lump sum

This allows the payment of all scheme benefits to enable the winding up of a pension scheme. This will only apply to an occupational scheme, e.g. a SSAS, when strict criteria are met. If a scheme is winding up the following key points should be noted:

  • The maximum amount that can be treated as a winding up lump sum is £18,000.
  • The member must have available LTA and the payment must extinguish all the member’s entitlement to benefits under the scheme.
  • Any employer of the member at the time the lump sum is paid, who has made contributions under that scheme in the last five years in respect of the member receiving the payment:
    – Cannot be making contributions under any other pension scheme in respect of the member, and
    -Must undertake to HMRC not to make contributions for one year after the lump sum is paid.
  • Where the lump sum is being paid from uncrystallised funds 25% is tax free with the remaining 75% taxed as pension income. Where funds are already in payment the whole of the lump sum will be taxed as pension income.

It is worth noting that if HMRC believe the wind up of a scheme is purely to facilitate this lump sum payment they could levy a £3,000 penalty.

Trivial commutation

This allows members with small Defined Benefits (DB) pension pots the freedom to take all their benefits as lump sum rather than via a series of small annuity payments.

From 16 September 2016 trivial commutation lump sums can only be paid in respect of DB arrangements, or scheme pensions under money purchase arrangements. These will in the most part not be payable under SIPP or SSAS.

Similar to Small Pension Pot, the benefit is not tested against LTA. However, the member does need to have some available LTA.


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