EIM75080 - The taxation of pension income: pension payments exempt from tax

Overview
Lump sums paid from registered pension schemes
Pensions paid to a beneficiary
Disability pensions paid due to injury or illness at work
Child dependency increases to social security pensions
Pensions paid under health and employment insurance policies
Armed forces exemptions
Pensions paid in respect of death due to war service
Exemptions for victims of persecution
Former miners’ coal and fuel allowances
Church of England Pensions Board payments
Malawi, Trinidad and Tobago and Zambia government pensions
Foreign pensions of consular employees
Certain pensions paid to non-residents

Overview

Certain types of pension payments are fully or partly exempt from Income Tax.

There are other payments from certain charitable funds that are not covered by specific exemptions but are instead not treated as pension income.

Lump sums paid from registered pension schemes

Sections 636A(1) to (2) and 636B ITEPA 2003

Registered pension schemes can pay out various types of lump sum payments. Legislation sets out the precise circumstances in which particular lump sums are paid and, in some cases, the maximum amount.

The tax treatment of the lump sum depends on the type of the lump sum. Some lump sums are totally exempt, whilst others are partially exempt. Some lump sums are taxable as pension income.

For guidance on the tax treatment of lump sums paid to members see EIM75420 and for lump sum payments following the member’s death see EIM75620.

Pensions paid to a beneficiary

Sections 573(2A) to (2F), 579CZA and 646B to 646F ITEPA 2003

Certain annuities and pensions paid following the death of a member or beneficiary may be exempt from Income Tax. These could be paid from:

• a registered pension scheme
• an overseas pension scheme
• a relevant non-UK scheme (RNUKS)

EIM75600 provides an overview of the treatment of pensions paid following the death of a member of a pension scheme. The page also provides an outline of the definition of an overseas pension scheme and RNUKS.

The important requirements for tax-free treatment are:

• the annuity started to be paid after 5 April 2015
• the member or beneficiary was aged under 75 when they died
• where the payment is an annuity the member or beneficiary died after 2 December 2014

For full details of the conditions which enable an annuity to be tax-free see EIM75640.

For details of the conditions for tax-free payment of drawdown pensions see EIM75660.

Disability pensions paid due to injury or illness at work

Section 644 ITEPA 2003

Certain disability pensions are fully or partly exempt from Income Tax, where it is paid because an individual has both:

• been disabled by an injury at work or through a work-related illness, or suffered a war injury
• ceased holding their office or their employment as a result

The amount of the pension that is exempt (if any) is calculated based on what pension would be payable to the individual if they retired due to the same illness or injury but instead it was not related to work or war injuries. If in these alternate circumstances:

• no pension would be payable, then the whole disability pension is exempt, that is, tax-free
• a pension of a smaller amount would be payable, then only the extra amount payable because of the disability being work (or war injury) related is tax-free
• the same amount of pension would be payable, then none of the disability pension is exempt and the whole amount is taxable

What is not covered by the exemption

The exemption does not apply to any pension or annuity paid under a registered pension scheme. Any pension or annuity paid under such a scheme on ill-health grounds will be taxable. This includes any increase given to the pension paid from the scheme because the member is retiring due to ill-health. However, if the employee receives extra pension in consequence of their ill-health being work-related, and it is not paid from a registered pension scheme, this extra pension may be exempt.

The exemption does not apply where the person who has suffered the illness or injury dies and a pension is subsequently paid to their beneficiary. This is because the beneficiaries’ pension is paid because of a person’s death, and not because a person has suffered a work-related injury or illness.

There are separate, specific provisions for disability pensions paid in respect of service in the armed forces; see EIM75920.

Child dependency increases to social security pensions

Section 645 ITEPA 2003

The recipient of a social security pension (see EIM75700) such as the State Pension may receive an increased amount if they have a dependent child. These increases are commonly known as child dependency increases. Any part of such a pension that is attributable to an increase in respect of a child is exempt from Income Tax.

Pensions paid under health and employment insurance policies

Section 644A ITEPA 2003

A pension or annuity paid from an insurance policy taken out to protect a person from sickness, disability or unemployment, to which an employee has contributed, is exempt from tax under certain conditions. The pension or annuity payments must meet the same conditions as non-pension or non-annuity annual payments under the policy would need to meet to be exempt from Income Tax under section 735 ITTOIA 2005; see the Insurance Policyholder Taxation Manual at IPTM6110 for further details of these conditions. In addition, the following conditions must all be met for the pension or annuity payments to be tax-free:

• the payments must be made to the person who paid the contributions in respect of premiums under the insurance policy or to their spouse or civil partner
• the policy must have been taken out by someone else wholly or partly for the person’s benefit
• the payments must be attributable on a just and reasonable basis to the contributions paid under the policy

Armed forces exemptions

Certain pension payments and allowances paid to members of the armed forces in respect of disability caused by service, and to their survivors where death was caused by service, are exempt from tax. Certain additional pensions and annuities paid in respect of awards for bravery may also be tax-free, along with ill-health lump sums provided under an armed forces early departure scheme. See EIM75920 for details of armed forces pension payments that are exempt from tax.

Pensions paid in respect of death due to war service

Sections 639 and 640 ITEPA 2003

Specified pensions or allowances paid by or on behalf of the Ministry of Defence will be exempt where they relate to death due to service in the armed forces or merchant navy or due to war injuries. EIM75920 provides more information about these payments.

The Civilians Scheme

The Personal Injuries (Civilians) Scheme 1983

The Civilians Scheme covers civil defence volunteers and civilians who received war injuries during the 1939 to 1945 war and their dependents. The scheme is administered by the Veterans Agency, which is part of the Ministry of Defence. The scheme is separate from the social security system. Payment awards may be made in favour of:

• civil defence volunteers
• employed or self-employed persons
• unemployed persons
• persons aged between 15 and 24 who were in full-time education, or were learning a profession or trade
• widows and dependent children, and in some cases parents and siblings, of persons who died because of their injuries

Payments made to injured persons are regarded as compensation for injury and not as income and are therefore not chargeable to Income Tax. Payments made to relatives of persons who died are regarded as income but are exempt from tax.

The amount of pension or allowance payable under any one of these provisions may be withheld because of another pension or allowance. Where that happens an amount of the other pension or allowance equal to the withheld pension is exempt from tax instead.

Exemptions for victims of persecution

Sections 642 and 642A ITEPA 2003

The following payments are exempt from tax:

• a pension or annuity payable under any special provision for victims of National-Socialist persecution made by the law of Austria or any part of the Federal Republic of Germany
• a pension, annuity, allowance or other payment provided in accordance with the provisions of the scheme established under the law of the Netherlands known as ‘Wet uitkeringen vervolgingsslachtoffers 1940 to 1945’.

Former miners’ coal and fuel allowances

Section 646 ITEPA 2003

A provision of coal or smokeless fuel, or an allowance paid in lieu of such a provision, to a former colliery worker or their surviving spouse or civil partner is exempt from Income Tax if certain conditions are met. These are:

• the amount of coal or fuel provided, or in respect of which the allowance is paid, must not substantially exceed the amount required for personal use
• the former colliery worker must have been a coal miner or employed at a colliery otherwise than in clerical, administrative or technical work

Church of England Pensions Board payments

The Church of England Pensions Board make payments out of 2 charitable funds:

• The Clergy Pensions Augmentation Fund
• The Clergy (Widows and Dependants) Augmentation Fund

Apart from certain payments to widows and dependants to which the Board applies PAYE, payments made from these funds are treated as non-taxable gifts instead of pension income.

Malawi, Trinidad and Tobago and Zambia government pensions

Section 643 ITEPA 2003

Under the Overseas Pensions Act 1973, the UK government took responsibility for paying certain government pensions. Government pensions paid for Malawi, Trinidad and Tobago, and Zambia may be exempt from tax in certain circumstances when paid to a pensioner who retired before 6 April 1973, or their surviving spouse or civil partner. For further information about this exemption see EIM75500.

Foreign pensions of consular employees

Section 646A ITEPA 2003

Some foreign pensions paid to UK residents who are consular officers or employees for a foreign state may be exempt from Income Tax. EIM75500 explains the conditions that must be satisfied for the foreign pension to be tax-free.

Certain pensions paid to non-residents

Sections 647 to 654 ITEPA 2003

Certain pensions are exempt from Income Tax when paid to recipients who are not resident in the UK. A person is taken to be not resident only if a successful claim is made to HMRC. No liability to Income Tax arises on pensions paid:

• from the Central African Pension Fund – see section 648
• out of a fund established in the UK by a Commonwealth government for the sole purpose of providing pensions in respect of service under that government – see section 649
• under the Oversea Superannuation Scheme – see section 650
• under Section 1 Overseas Pensions Act 1973, whether it is paid out of a fund established under a scheme made under the Act – see section 651, however, any part of the pension that the Pensions (Increase) Acts apply to is taxable.
• under the authority of the Overseas Service Act 1958 if it meets certain conditions – see section 652
• out of the Overseas Service Pensions Fund, including any sum payable in respect of ill-health – see section 653
• under the authority of the Pensions (India, Pakistan and Burma) Act 1955 – see section 654, however, any part of the pension that the Pensions (Increase) Acts apply to is taxable

For the purposes of these sections, ‘pension’ includes a gratuity or any sum payable on or in respect of death, a return of contributions, and any interest or other addition included in a return of contributions.

Any questions about these exemptions should be referred in the first instance to the Income Tax: general enquiries helpline on 0300 200 3300 who deal with most cases that are affected.