Can’t pay? Have to pay – correcting underpaid lump sums

Helen Powell

It’s not uncommon for a pension scheme to discover that a mistake has led to a pension being put into payment at less than the correct amount. There are helpful regulations to deal with payment of pension arrears, and plenty of industry experience of dealing with this kind of problem. What trustees can’t easily do, though, is pay a top-up tax-free pension commencement lump sum (PCLS), to put the member into the position he or she would have been in, had the pension been calculated correctly from the start.

The problem arises because a PCLS can only be paid within a specific time period linked to the member becoming entitled to their benefits – so if the mistake is discovered more than one year after that point, a purported PCLS would be an unauthorised payment. This could be a live issue for many schemes in connection with corrective payments following a GMP reconciliation exercise. It’s one of a number of areas we have identified where easements from HMRC would help to streamline correction processes for schemes.

The Pensions Ombudsman has also been considering the point, and his determination is an example of bad news potentially being rather good news for schemes. Here’s what happened:

  • Mr E retired in 2012. In 2014, new administrators discovered an error in the calculation of his final pensionable salary, on which his pension was based. The scheme corrected the pension in 2015.
  • The Trustees rejected Mr E’s request for a top-up PCLS because this would breach the scheme rule against making unauthorised payments and trigger tax charges; it paid £500 compensation for distress and inconvenience.
  • The Ombudsman ruled that the scheme should have offered a PCLS based on the shortfall (plus interest) even though this could trigger tax charges to both the member and the scheme, and that the scheme should pay those charges, because the mistake was caused by the Trustees’ misinterpretation of the rules.

At first sight this would be very bad news for schemes if applied to the GMP rectification situation* − it could potentially lead to widespread requirements to pay unauthorised payments in the form of top-up PCLS, and for schemes to pay the related tax charges in addition.

However, the Ombudsman highlighted section 241 of the Finance Act 2004, which says that an unauthorised payment will not trigger the normal tax charges if:

‘it is made to comply with an order of a court or of a person or body with power to order the making of the payment, or it is made on the ground that a court or any such person or body is likely to order the making of the payment (or would be were it asked to do so)’.

This is potentially very helpful. As the first known example of the Ombudsman ruling on this issue, it gives other schemes grounds to argue that scheme sanction charges should not apply in this scenario. The Ombudsman also thought it was ‘entirely possible’ that HMRC would make a concession on unauthorised payments charges payable by the member (but in this case to be paid by the scheme) on the basis that the original miscalculation had been a genuine mistake. As noted below, in the GMP rectification situation, the mistake may well have been on HMRC’s part, not the trustees’, which would strengthen the case for seeking a concession.  That’s not risk-free, of course – we would prefer, and will continue to request, an easement from HMRC so that schemes have a reliable basis on which to make corrections. On an optimistic note, it may also be the case that the existence of this ruling helps HMRC to provide a positive response to that request.

*It’s worth noting that GMP rectification is not a direct parallel, because corrections are not necessarily based on an error/maladministration by the trustees – this should strengthen the case for an easement.

Helen Powell is a PSL Counsel at Allen & Overy LLP

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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