Cash in small pension funds & get a larger lump sum
Under current UK pensions legislation your pension fund ultimately has to provide you with a retirement income and, if you choose, a small tax-free lump sum (usually 25% of the fund value). But, if the value of your pension savings is small it is possible to give up your rights entirely and cash in small pension funds and receive a larger cash lump sum.
Cash in small pension funds (trivial commutation)
Under the trivial commutation pension rule it is possible for those with ‘small’ or ‘trivial’ pension pots to take their pension fund as a cash lump sum, with 25% of it paid tax-free and the remaining 75% taxable as income in the tax year in which it is paid.
And the rules don’t just apply to pension pots not in payment. It is possible to apply the rules when a pension is already in payment but the payment is ‘small’. In this instance the entire lump sum is deemed taxable when the trivial commutation rules are applied.
However, there are certain conditions that need to met before you can cash in small pension funds, namely:
- You have to be 60 or over
- The total sum of all your pension savings are valued at £18,000 or under (which is the definition of ‘trivial’).
If the above apply then it is possible to take your entire lot as a cash lump sum (25% tax-free, the remainder taxed as income).
However small final salary pension entitlements are included in the triviality calculation. While the calculation is fairly complex (ask your scheme administrator to provide a valuation for these purposes) the upshot is that if you are entitled to as little as £1,000 pension a year from a final salary scheme you would not be able to cash in any small pension pots under the pension triviality rule.
Pension pots worth less than £2,000
However, since the above rule was introduced it has been extended to include a concession that even if your total pension savings exceed the £18,000 limit you can cash in up to two pension pots if they are valued at £2,000 or less.
If your small pension is a personal pension contract, not yet in payment, which is based on the contributions you pay then you simply look at the capital value when making an assessment of its value.
If your pension pot is valued at £2,000 or under there are different rules relating to cashing it in depending on whether it is a company, public or personal pension scheme (more detail here).
How to cash in pension funds in practice
If you wish to cash in any pension pots then you need to contact the scheme administrator(s) to see if they allow it. If they do then they will value your pension plan(s) for you (plus they may ask for valuations of any other pension benefits you have) to see if you are eligible before facilitating any payment.
Other points to consider when cashing in small pension pots:
- All planned trivial commutations must be made within 12 months of the date of the first lump sum payment.
- You can’t cash in part of a pension plan.
- Would deferring cashing in a pension help mitigate the income tax payable on the lump sum (i.e. to a time when you are a non-tax payer) ?
- You can only cash in small pension funds under the’ £2,000 rule’ twice in your lifetime
- If you receive means-tested state benefits then any lump sum will increase your personal capital and could make you ineligible to continue claiming that benefit.
As you can see the rules surrounding trivial commutation are tricky so seek advice from an independent financial adviser before you attempt to cash in small pension funds. If you do not have an independent financial adviser you can trust then the red box in the right hand column can put you in touch with an adviser with specialist pension knowledge.
(image by James Barker via freedigitalphotos.net)
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