HMRC has confirmed that interest on pension arrears lump sum payments should be taxed as interest under the Income Tax Act 2005, in what has been highlighted as a “welcome boost for hard-pressed pensioners”.

In the Pension Schemes Newsletter June 2022, HMRC explained that interest payments made in addition to a payment of pension arrears, that meet the definition of a scheme administration member payment, are taxable as interest under section 369 Income Tax (Trading and Other Income) Act 2005.

It also confirmed that interest payments will qualify as scheme administration member payments, and so as authorised payments, where interest is provided on an arm’s length commercial basis.

Where pension arrears are paid in connection with equalising for the effect of unequal guaranteed minimum pensions (GMP), and interest is provided at 1 per cent above base rate or at an interest rate specified in the scheme rules, the interest will also be treated as a scheme administration member payment.

LCP head of GMP equalisation, Alasdair Mayes, described the updated guidance as "a welcome boost for hard-pressed pensioners", noting that lots of pensioners are due to receive lump sums where their pension was underpaid in the past due to GMP equalisation.

“Confirming that any interest included in the lump sum should not be taxed as pension, but rather should be paid gross and taxed in the same way as bank and building society interest means most pensioners will not need to pay tax on the interest they receive – few basic rate tax payers use up their £1,000 personal savings allowance," he stated.

"The sums involved may not be large, but every little helps.”

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