Oh no! We’ve got a disqualifying pension credit

I was recently asked how a pension scheme should deal with a disqualifying pension credit (broadly, a pension credit arising from benefits that were already in payment when the pension sharing order took effect).

In particular, I was asked exactly when / if the benefits provided for an ex-spouse that arise from a disqualifying pension credit are tested against the Lifetime Allowance and, given that the benefits that had become subject to the pension debit (the debit that gave rise to the pension credit in question) had been designated for capped drawdown, whether the ex-spouse should be offered capped drawdown in respect of that pension credit?

Where a pension credit is used (either within the same scheme as the member whose benefits became subject to a pension debit or in another scheme) to provide the ex-spouse with a pension credit benefit, that pension credit benefit is inherently uncrystallised at the point that the pension credit benefit is created. This applies even where the benefits that gave rise to the pension credit were already in payment.

This can be illustrated by considering an example where the member (whose benefits became subject to the pension debit were already in payment) was previously married to a spouse under the age of 55. In this case, the ex-spouse could not be entitled to any immediate payment of benefits from the pension credit, so they must be uncrystallised. Even where the ex-spouse is aged over 55, there is no legal requirement that the pension credit must be used to provide for the immediate payment of benefits – the ex-spouse could choose to defer any benefits available from the pension credit to a later date. (This is, of course, subject to the Scheme Rules, however I hope that it serves to illustrate the point.)

The benefits arising from the pension credit, then, only crystallise at the point that the ex-spouse actually becomes entitled to the payment of those benefits (or reaches age 75 without taking them), in line with the usual BCE provisions. There is no special treatment for pension credit benefits here.

If a scheme receives a pension credit that arose from benefits that had been designated as available for capped drawdown, that pension credit still arrives as an uncrystallised benefit: again, consider the example of the ex-spouse being below age 55.  

If/ when the ex-spouse wishes to take that benefit as a form of drawdown, the ex-spouse would have to designate those funds as being available for drawdown. As this designation would be made on or after 6 April 2015, the funds would have to represent a flexi-access drawdown fund. This is because no other form of drawdown is available where funds are designated on or after that date. It is, therefore, not possible to offer capped drawdown in this situation.

There are, however, some special rules to bear in mind when dealing with a disqualifying pension credit.

Firstly, where the member became entitled to the benefits against which the pension credit arose on or after 6 April 2006, the pension credit benefits will be “double tested” against the Lifetime Allowance (LTA). This is because they would have been tested against the original member’s LTA when the member first became entitled to them and will be tested again against the ex-spouse’s LTA when the ex-spouse becomes entitled to them. To offset this double-counting, the ex-spouse can apply for a LTA enhancement factor in respect of the pension credit. Further details of this, and the required notification procedure, are available in the PTM at: https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm095200.  

Secondly, where an individual designates funds as being available for flexi-access drawdown, they usually become subject to the Money Purchase Annual Allowance at the point that the first drawdown payment is made to them. This does not, however, apply where all of the funds designated as being available for flexi-access drawdown arose from a disqualifying pension credit. 

Finally, an ex-spouse cannot take either a Pension Commencement Lump Sum or an Uncrystallised Funds Pension Lump Sum from any benefits arising from a disqualifying pension credit.

Pension credits can often be a cause for confusion for pension schemes because, for any given scheme, they do not tend to arise all that often. This is particularly true for disqualifying pension credits. I hope that this summary of the requirements that apply here is helpful.

Aries Insight provides comprehensive and detailed guidance on the operation of pension sharing and the treatment of pension credit benefits, as well as insight into the meaning and impact of UK pensions regulation and clear guidance on the practical implications for pension providers, trustees, administrators and consultants. If you are not already an Aries member and would like to find out more about what Aries Insight can offer you, then please drop me a mail at [email protected] or give me a call on 01536 763352.

Please note that we are not lawyers or financial advisers. The information above sets out our best understanding of the legislation and how it applies, but should not be taken as constituting legal or financial advice.