If you’ve received some pension compensation, you’ll want to know if you’ll be taxed. This will depend on why and how your pension compensation was awarded. You might find that you’re completely exempt from any compensation tax, or that you should pay tax on some of the money you’re awarded.
There’s no clear-cut answer to the question ‘Is pension compensation taxable?’. Many factors must be taken into account, though it’s possible that some of your pension compensation will be taxable and need to be declared.
It is highly unlikely that you’ll be taxed on the full amount or the majority, though it’s important not to simply assume that you’ll get to keep every penny.
Read on to learn more about pension compensation and when the money you receive might be taxable.
We update all our guides regularly. If you are researching pension fraud and we haven't got an exact guide that helps you, keep coming back as we update daily.
You might be entitled to compensation if your pension was mis-sold. Bad advice can lead to financial losses that compensation will help to make right.
You can claim compensation by making a complaint, and you may be given up to £85,000 by the Financial Services Compensation Scheme (FSCS).
You have up to six years to act, from the day that you discover you’ve been misled or have a potential complaint.
You might receive pension compensation if it’s found that you’ve lost out financially. Perhaps poor advice led to you choosing the wrong type of pension, or you were pushed towards a SIPP that you didn’t know how to manage? Maybe you transferred away from an employer’s pension, and lost money with your personal pension?
People don’t always get the best advice about their pensions, though you shouldn’t lose money as a result of information that someone else has given.
Typically, pension compensation is designed to give you back any money that you’re likely to have lost. If you received bad pension advice that’s caused you to miss out on money, the Financial Services Compensation Scheme should do what it can to correct this.
Decisions are made, usually, by the Pension or Financial Ombudsman. They'll need to determine if compensation is deserved, as well as how much to award. Very few people can put an exact monetary value on their loss – who's to know exactly how your investments would have risen and fallen?
The amount of compensation you receive won't be exactly what you lost either since in most cases you'll also be covered for the interest you would have received.
Over time, the value of money will change. A monetary figure in the 1980s would be worth much less today. Your compensation should consider any economic changes and how the fund's value would adjust.
Though it's much less common, pension compensation can also cover emotional impact. A small sum may be paid if your situation has caused some distress, which in many cases it will have done – no one loses their life savings without feeling at least extremely upset.
Your pension compensation may be paid into your existing pension savings. There's also a chance that the money could be paid as a lump sum into your bank account. Decision-makers will specify how compensation should be awarded, so you can speak up if the money is received in a way that you weren't expecting.
Pension compensation can be tax-exempt. There's one very specific scenario for getting pension compensation with absolutely no applicable taxes.
Mis-sold personal pensions are exempt from both income tax and capital gains tax, if you meet all three of the following conditions:
Obviously, the above conditions will only apply to a small number of people. There are, however, many other ways that your compensation could be tax-exempt. Usually, at least some compensation will be exempt from tax, though you may be required to pay further tax on some elements of your award.
You won’t usually pay tax on any compensation that restores you to your original financial position. You will be taxed on any interest you earn on your compensation, and will also be taxed for elements of compensation that are considered an additional reward.
This means that you’ll be taxed on the compensation you’ve received for emotional distress that you’ve suffered.
Your compensation value is likely to cover the original money that you lost, as well as what you would have been expected to earn in interest from the date of the event. If you’d earned this interest over several years or decades, it would have been taxed at the time. Now you’re receiving it all at once, the relevant taxes still apply.
The goal of compensation is to set things right and get them exactly where they should have been already. It’s very rare that awarded compensation will put someone in a better situation.
In most cases, whoever is paying compensation should deal with the tax on your behalf. This might mean that you receive a smaller figure than the compensation you were awarded. Depending on your situation, compensation may be paid into your pension fund or as a lump sum to your bank account.
It helps to plan ahead, so if you want to know what compensation level you could be eligible for, you can use the Financial Services Compensation Scheme’s own limit tool. It tells you how covered you are based on who manages your pension fund, and its value.
It’s a good way of understanding how much you are due, so that you can discuss this figure with your financial adviser to understand how much of it will be taxable.
You can find the tool at this link: FSCS What we Cover
If you’ve received compensation and it hasn’t been taxed, you’re responsible for setting things right. You should check if you owe any tax, and make arrangements to pay it back in a way that works for everyone involved.
HMRC can tell you exactly how much tax you will owe. You can contact the HMRC helpline to talk about the money you’ve received. If you’ve received the compensation as a direct lump-sum payment, it’ll be up to you to make arrangements to pay any outstanding tax. This might include income tax and capital gains tax, paid to HMRC once declared.
It might be that any outstanding tax has already been paid on your behalf. This is likely if the amount you’ve received is lower than the original gross compensation figure you were awarded. If you’re in any doubt, check paperwork and statements to see what you might still owe in taxes.
It may be that your pension compensation tax is paid before you get your share. If that’s the case, there might be nothing outstanding that’s still owed to HMRC.
If you’re concerned about falling foul of pension compensation tax rules, it’s always best to speak to a professional financial advisor. They can help with the relevant laws, precedents and sifting through your paperwork.
Circumstances vary, and there’s no easy answer or way to calculate how much you might owe.
Here at Money Savings Advice, we have partnered with some of the UK’s leading Financial Claims management companies. They have already helped thousands of people claim compensation for a mis-sold pension and they can do the same for you.
Choosing an independent claims management company means they won’t proceed with a claim unless they are sure it is in your best interests. They are also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these claim management companies who can help you make a compensation claim, then click on the below and answer the very simple questions.
How does Money Savings Advice work
Money Savings Advice is an independent editorial company providing detailed information about numerous financial niches with the aim of helping consumers make informed financial decisions. We aim to provide hints, tips and techniques to help you make your money work for you. However, we are not perfect, and we accept no liability if anything we write about goes wrong.
Money Savings Advice is a trading name of RMM Digital Publishing Ltd. Registered trading address, First Floor, 85 Great Portland Street, London, W1W 7LT. Trading in England and Wales, company number 11550143 with data protection number ZA747669.
Money Savings Advice is a trading style of Consumer Credit Justice Ltd.
Consumer Credit Justice Limited is authorised and regulated by the Financial Conduct Authority, Reference 834486. We are regulated by the FCA in respect to claims management activities.
You do not need to use the services of Consumer Credit Justice, or any other claims management company, to make a claim. You are free to choose an independent solicitor of your choice.