HMRC has published updated guidance on the tax implications for pension scheme members of lump sum payments made to them as a result of guaranteed minimum pension (GMP) equalisation.

So, do we finally understand the tax consequences of equalisation? In short, no.

Lloyds Judgment on GMPs

We’ve known since 1990 that pension schemes must equalise their ordinary pension benefits for men and women, but the 2018 Lloyds Bank case confirmed that benefits must also be adjusted to counteract the unequal effect of GMPs. GMPs were earned by pension scheme members who were contracted out of the State Second Pension before 6 April 1997. The Lloyds Bank case considered various methods of GMP equalisation open to trustees and pension providers.

We have already commented on initial guidance provided by HMRC on the tax consequences of GMP equalisation, but there were still questions on lump sum payments, death benefits, and the use of the potentially popular conversion method of GMP equalisation (method D in the Lloyds Bank case where GMPs are converted into ordinary scheme benefits).

Lump Sum Payments – Authorised or Unauthorised?

The payment of certain lump sums is expected to extinguish the members’ benefits under the scheme, for example trivial commutation or winding up lump sums. It is possible that, following GMP equalisation, the member is due to receive a lump sum top up.

This has raised concerns that any additional payments will trigger unauthorised payment charges. HMRC has confirmed that where a scheme identifies a further entitlement in the scheme purely as a result of GMP equalisation, then the payment of the top up will not result in the lump sum being unauthorised.

Similarly, some lump sums have maximum limits, eg. pension commencement lump sums. Except for trivial commutation lump sums (covered below), so long as the previous lump sum was within the prescribed limits, the lump sum will not become unauthorised if further entitlement (deriving purely from GMP equalisation) is identified.

Additional Rules for Trivial Commutation Lump Sums

The exception to the above rule is trivial commutation lump sums. Here, if as a result of GMP equalisation, the member’s entitlement is greater than the trivial commutation lump sum limits applicable at the time of initial payment (eg. pre-27 March 2014 the limit was £18,000), the trivial commutation lump sum will be an unauthorised payment.

This will be disappointing for some members who will face tax consequences as a result of GMP equalisation. HMRC’s reasoning is to align the approach with that taken in respect of the annual and lifetime allowances: it does not treat GMP equalisation as conferring a new benefit to members; instead, the benefit was accrued prior to 6 April 1997.

Taxation on ‘Top-Up’ Payments

Top-up payments must meet any legal requirements that applied at the time of the payment, and will be taxable under the tax rules in the year they were originally paid.

If a top-up payment would be unauthorised (eg. a top-up to a trivial commutation lump sum paid more than 12 months ago or a serious-ill health lump sum where the member is now deceased), then schemes may be able to rely on the Registered Pension Schemes (Authorised Payments) Regulations 2009.

This authorises lump sum payments up to £10,000 in certain circumstances, including where the trustees discover an error (for example valuation errors for transfers).

It is likely that a top-up as a result of GMP equalisation would fall under the small lump sum regulations, but you should check with your legal advisers to make sure.

Taxation on GMP Conversion?

While the new guidance is a welcome steer for trustees and pension providers undergoing a GMP equalisation exercise, it is disappointing that there is no guidance on the tax consequences of the conversion method.

This is especially disappointing as conversion is the method that the DWP has been actively promoting. HMRC states that it is unable to provide such guidance at this time as more detailed work is required for the wider issues associated with conversion (such as interaction with lifetime allowance protection, and whether the deferred member carve out applies).

GMP equalisation is not an easy task, but is one which most previously contracted-out schemes will now be considering.

If you have any questions in relation to GMP equalisation for your scheme, please get in touch with a member of the pensions team.