EIM75900 - The taxation of pension income: public service pension payments

Payments of pension from pension schemes
Payments from compensation schemes
Armed forces
Local government gratuities
Members of Parliament

Payments of pension from pension schemes

Sections 569 and 579A ITEPA 3009

Most public service pension payments are taxable under either:

• section 579A if they are paid from a registered pension scheme (see EIM75400)
• section 569, which taxes pensions paid by or on behalf of a person in the UK, including pensions and annuities paid by the Crown (see EIM75200).

However, there are separate compensation and injury benefits schemes that can make tax-free payments in certain circumstances.

Payments from compensation schemes

Payments from certain compensation or injury benefits schemes, such as those for police and firefighters, can be paid tax-free. Such payments are usually made where a person has been disabled by an injury at work.

Where a person also receives an ill-health or other pension from their registered pension scheme, the tax-free payment they are entitled to receive from a compensation or injury benefits scheme may be reduced by the amount of the pension payable from the registered pension scheme.

In these circumstances the amount payable from the registered pension scheme is taxable and only the reduced amount payable from the compensation scheme is tax-free.

Details of when and how a compensation scheme payment may be paid will be given in the scheme rules. See EIM75080 for further information about exemptions where a pension is paid where a person is disabled by an injury at work or through a work-related illness.

Armed forces

Certain pension payments and allowances paid to members of the armed forces where they have been disabled in 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.

Local government gratuities

Under the Local Government (Discretionary Payments) Regulations 1996 (SI 1996/1680) local authorities had the discretionary power to pay gratuities on termination of employment to employees who have not been members of the Local Government Pension Schemes. Gratuities for retirement or death in service may be made under separate schemes for death in service and retirement. Typically, these were payable to parish council clerks.

The retirement gratuity was payable as either or both of a lump sum and an annuity. Generally, the capital value of the retirement gratuity was three-eightieths final pay for each year of service in the employment. The retirement gratuity was payable as either or both of a lump sum and a pension.

The tax treatment of the retirement gratuity depends on:

• if the scheme making the payment is a registered pension scheme
• whether or not that scheme was an approved retirement benefits scheme before 6 April 2006
• how much of the gratuity relates to service after 5 April 2006.

Where the gratuity scheme was an approved scheme before 6 April 2006, it automatically became a registered pension scheme on 6 April 2006.

Scheme approved pre-6 April 2006, no pensionable service after 5 April 2006

Where the gratuity payment from such a scheme relates to pre-6 April 2006 service only the gratuity can be paid as a tax-free lump sum. The payment should be a ‘stand-alone lump sum’ – see PTM063130 to find about more about this type of lump sum payment.

Scheme approved pre-6 April 2006, service after 5 April 2006 pensioned

Where the gratuity paid from a scheme that was approved before 6 April 2006 relates to both pre- and post-6 April 2006 service, to receive the maximum tax-free payment part of the gratuity must be paid as a pension. Where the gratuity is paid as part lump sum and part pension, the lump sum payment is a ‘pension commencement lump sum’ payable under the scheme specific lump sum protection rules. The maximum tax-free amount is broadly the value of the gratuity as it stood on 5 April 2006 plus 25% of the remaining gratuity. PTM063130 provides detailed guidance on the maximum amount of tax-free lump sum.

If no pension is provided the whole payment is taxable as an unauthorised payment (see PTM131000 for further details).

The pension element of the gratuity may be commuted into a lump sum where the value of the pension element is not more than £10,000 (£2,000 if paid before 27 March 2014). The lump sum is taxable as pension income at the individual’s marginal rate of tax. PTM063130 provides more information about this.

Scheme registered on or after 6 April 2006

The maximum tax-free lump sum is 25% of the amount of the gratuity. To have this treatment the remaining 75% of the gratuity must be paid as a pension. If no pension is provided the whole payment is taxable as an unauthorised payment (see PTM131000 for further details).

If the total value of the gratuity (lump sum and pension) is not more than £10,000 (£2,000 for payments made before 27 March 2014) it may be possible for the pension part of the gratuity to be commuted into a taxable lump sum payment. This would be under the provisions of regulation 11 of the Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171). PTM063700 provides more information about the conditions that need to be satisfied for the pension to be commuted into a lump sum. The lump sum is taxable as pension income at the individual’s marginal rate of tax.

Gratuity scheme not registered

Due to the relatively small level of gratuities permitted under the 1996 regulations, most local authorities are likely to make the payments themselves directly under an employer-financed retirement benefits scheme (EFRBS). The lump sums will therefore be within section 393 ITEPA 2003 (see EIM15100). If, unusually, the lump sum is not paid directly by the local authority but is instead paid via a third party, the rules at Part 7A ITEPA 2003 may apply (see EIM45000).

Death lump sums remain tax exempt.

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

Members of Parliament

Sections 619 to 622 Income Tax (Earnings and Pensions) Act 2003

Periodical payments made from the House of Commons Members’ Fund, or out of sums appropriated from the fund, or out of income deriving from those sums, are taxable as pension income. PAYE applies to these payments so the payer must apply the PAYE rules before paying the annuity.