Will compensation payments for poor pension transfer advice be taxed?

Since the pension rules changed in 2015, the number of investors being advised to transfer out of defined benefit, often known as final salary, pension schemes into other investments has increased considerably. Many such investors were advised to take more flexible cash lump sum arrangements, but the regulator’s view is that most people would have been better off remaining in their final salary pension scheme. 

Where an individual has received poor pension advice, they may be entitled to a redress payment from their investment adviser or, where their investment adviser has gone out of business, to compensation from the Financial Services Compensation Scheme. 

The tax position of these payments is complex. While there is a specific exemption for compensation for some mis-sold pensions, the conditions to be met are very restrictive. The bad advice must have been given between two specific dates: 29 April 1988 and 30 June 1994. This will not help those making more recent transfers and claims, who may find they have to pay tax on some, but not all the payments they receive. 

Any interest element in the payment will be chargeable to income tax at the individual’s highest rate of tax. But the rest of the compensation is likely to be treated as a capital sum, potentially making it subject to capital gains tax. However, in the case of compensation arising from misleading professional advice, a concession may be applied by HMRC, so that the sum is treated as exempt up to £500,000. A lot depends on the specific analysis of each element of the compensation package. 

As always, it’s important to understand the make-up of the compensation payment to determine the true tax position and affected investors should always seek tax advice specific to their case.