If clients have small pensions, they may be able to take them as cash lump sums – up to three small pots of £10,000 each from non-occupational pension schemes and an unlimited number from separate occupational pension schemes, subject to scheme rules. Here we answer some common questions we are asked on these topics.
What is a small pot?
Q. What is a small pot (technically known as a small lump sum) payment and do all pension schemes offer this option?
A. Finance Act 2004, ie the legislation which applies to registered pension schemes, authorises specific types of lump sum payments that may be paid to members, one of which is a small lump sum. This payment type means that where a client has pension benefits that satisfy specific criteria, it may be possible to commute these for payment of a one-off (small) lump sum. There are different criteria depending on the type of scheme/ arrangement which holds the pension benefits. These conditions are covered in our article – small pots and defined benefit trivial commutations
Where a scheme offers this option, each payment cannot exceed £10,000 at the time it is paid.
Small pots from non-occupational pensions are limited to three in the client’s lifetime and each payment must extinguish pension rights held in the arrangement.
There is no limit on the number of small pots from occupational pension schemes providing each payment extinguishes benefits held in the paying scheme.
It is not mandatory that any scheme offers this option. You should check the scheme rules.
Advantages of small pot vs UFPLS
Q. Is there any benefit to receiving a small pot (lump sum) payment instead of an uncrystallised funds pension lump sum (UFPLS)?
A. Small pots do not use, or require the customer to have any available, lifetime allowance (LTA). So, they can be used to avoid LTA excess charges where someone has used all their LTA but has a stranded pot worth up to £10,000. An UFPLS payment is subject to the client having sufficient available LTA before age 75 and at least some remaining LTA on or after age 75.
Small pots can legislatively be paid from crystallised pension funds, UFPLS can only ever be paid from uncrystallised funds.
Although the initial tax applied may be different (usually small pots are taxed at basic rate and UFPLS at emergency rate), both types of payment are ultimately treated in the same way and any over or underpaid tax would need sorted out with HMRC directly.
Money purchase pension funds over £10k but less than £30k
Q. My client has a small SIPP worth £24,000. Can he take this as three small pots?
A. This may be possible depending on the provider who holds the arrangement. They may be able to separate this in to multiple arrangements. Be careful though if your client holds enhanced or any of the fixed protections (2012, 2014 or 2016) as setting up a new arrangement for this purpose would lose these forms of LTA protection.
This answer relates to non-occupational pension schemes only, as one of the conditions for a small lump sum payment is that each payment of up to £10,000 must extinguish the member’s rights under the arrangement making the payment.
This is fundamentally different from the condition for a small pot payment from an occupational pension scheme which must extinguish the member’s rights to benefits under the paying scheme.
Q:What benefits are taken in to account for the triviality option post 6 April 2015?
A: Pre-crystallisation, triviality is now only an option for the payment of defined benefit (DB) scheme benefits. Although it is only DB benefits that can be paid under this option, ALL pension benefits from any registered pension scheme (including those already crystallised and those which remain uncrystallised) are taken into account when valuing the benefits to test they do not exceed the commutation limit of £30,000.
Q. My client’s defined benefit (DB) pension scheme sent her a list of retirement options including ‘a trivial commutation lump sum’. They offered a lump sum payment, which would be subject to tax, of £22,500. When we told them about two small personal pensions also held, with funds of £5,000 and £8,000 respectively, they have withdrawn the option of triviality. Why is this?
A. As the value of pensions from all sources total £35,500, this exceeds the £30,000 commutation limit. This means your client is not eligible for triviality from her DB scheme benefits. The DB scheme would not have known this until you gave them values for your client’s other pension funds.
The HMRC rules for paying a trivial commutation lump sum state, as one of the conditions, that all of a member’s crystallised and uncrystallised rights under any type of pension arrangement are taken in to account when testing the £30,000 commutation limit. So, although since April 2015 (on retirement) it is only DB pensions that can be paid out under the triviality rules, the value for any money purchase pensions must still be included to work out if the client is eligible.
Q. Following on from the previous question, is there a practical solution that would allow the DB scheme benefits to be settled under triviality?
A. Yes there is. If the personal pension scheme worth £8,000 offers the small pot option you could take that payment first. This does not use up any LTA and reduces the value of funds to be tested against the commutation limit. This takes pensions from all sources below £30,000 (£22,500 + £5,000 = £27,500) making your client eligible for triviality from her DB scheme benefits.
Q. What pensions are tested against the £30,000 commutation limit for a trivial commutation lump sum death benefit?
A. This is fundamentally different from the rules for a trivial commutation lump sum on retirement. Where the triviality payment is offered in respect of a death benefit, £30,000 is the maximum amount per scheme, rather than the maximum across all schemes.