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Occupational pension schemes that were contracted out of the state second pension on a defined contributions basis should be aware of the tax position on short service refund lump sums from 6 April onwards.
One of the conditions for a payment to qualify for tax treatment as a short service refund lump sum is that the payment must extinguish all of the member’s entitlement to benefits under the scheme, except where FA 2004, Sch 29 para 5(1)(d) prevents it.
The exception includes situations in whichcurrently contracted out schemes must retain the member’s protected rights in the scheme when paying a short service refund.
But when contracting out in a defined contribution scheme is abolished on 6 April 2012, there will no longer be a legal requirement to differentiate between protected rights and non-protected rights.
Schemes with rules that may be interpreted as no longer needing to withhold protected rights when paying short service refunds will continue to be able to make refunds that satisfy the tax rules, because they will be able to meet the condition in Sch 29 para 5(1)(d) that the payment extinguishes the member’s benefits.
For the avoidance of doubt, this can include schemes that have already paid a short service lump sum but retained an amount in the scheme under the exception above.
Schedule 29 does not prevent a second short service lump sum being paid in respect of this retained amount, subject to it satisfying the requirements for short service refunds at the time it is paid.
However, occupational defined contribution pension schemes with regulations that prevent protected rights being paid out, and which have not amended from 6 April 2012 to allow for the refund of a person’s entire rights as a short service refund lump sum, will not be able to rely on the exception in of Sch 29 para 5(1)(d).
In such cases, schemes and administrators should note that any payment that represents only part of the member’s rights will no longer be a short service refund lump sum for tax purposes, and could become liable to unauthorised payment tax charges.
The tax rules for affected schemes are to be amended to allow them to pay a partial refund without incurring unauthorised payment charges. A consultation will follow, but not before 6 April.
Given that scheme administrator liabilities are increased by the proposed new rule, the regulations cannot have retrospective effect.
It is expected they will come into force in the summer and will apply for a transitional period, by the end of which affected schemes should have been able to make the rule changes necessary to comply with the existing tax rules for short service refund lump sums.
Schemes that are likely to be affected may wish to consider delaying such payments until they can either change their rules or take advantage of the new tax rule once the regulations have come into force.
