Pension triviality - 'small' pension pots

Small pots and defined benefit trivial commutations

What is a pension small pot payment?

Due the nature of working life many of us move employer several times and as a result we can leave behind small pension pots. If you have small pensions, you 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 occupational pension schemes, subject to certain rules.

Small pots - so what do you need to know?

1. A maximum of three small, non-occupational pensions can be commuted under small pot payments.

2. There is no limit to the number of occupational pensions that can be commuted under small pot rules.

3. A small pot payment (properly called ‘small lump sum’) can be made from any arrangement, whether the rights are uncrystallised or comprise a pension in payment, irrespective of the overall value of the individual's pension's worth. Up to three small non-occupational pensions (personal pension plans etc.) can be commuted under small pots payments, but there’s no limit on the number of occupational pensions that can be taken under small pots. To allow the payment of small pot commutation, the following conditions need to be fulfilled:

4. The member has reached the minimum retirement age of 55, or satisfies the definition for ill-health early retirement or has a protected early pension age each payment must not exceed £10,000 at the time it’s paid to the member

5. For non-occupational pension schemes, the payment must extinguish all member benefit entitlement under the arrangement

6. For occupational or public service pension schemes, the payment must extinguish the member’s entitlement to benefits under the paying scheme, in respect of non-occupational pensions (personal pensions etc.), there’s a maximum of three small pot payments are permitted. A full list of the conditions is in the Pensions Tax Manual (PTM063700) covering;

   1. Payments under occupational or public service pension schemes

   2. Payments under larger occupational or public service pension schemes

   3. Payments under a scheme that is not an occupational or public service pension scheme

Small pots from non-occupational pension schemes are about arrangements, not schemes

‘Small pots’ applies at arrangement level rather than scheme level. So the payments can be made from two or three separate registered pension schemes or from the same scheme where the payments are made from two or three different arrangements under that scheme.

Effect on entitlement to benefits

Small pot payments extinguish the member’s entitlement to benefits under the arrangement from which the payment is made, but not necessarily their entitlement under the scheme as a whole. A member can take a small lump sum even though they may still have an entitlement to benefits under another arrangement in that scheme.

Managing a large number of arrangements

For example 100 arrangements under the same registered pension scheme, where each arrangement contains well under the commutation limit under this regulation. Subject to what the scheme rules allow, these funds may be consolidated either by merging arrangements into a smaller number of arrangements or by a transfer of funds between multiple arrangements. This allows the maximum small pot to be taken from either one or each of two or three arrangements under the scheme. A ‘reshaping’ of existing arrangements (either by merging multiple arrangements or internal transfers of funds between multiple arrangements in the same scheme) won’t involve the setting up of a new arrangement. This avoids any potential consequences for members who have valid enhanced protection, fixed protection, fixed protection 2014 or fixed protection 2016.

Funds in excess of the commutation limit

If a member has funds in excess of the limit in an existing single arrangement, some of which are then moved into arrangements set up to allow a member to take one, two or three small lump sum payments under Regulation 11A, this will entail the setting up of one or more new arrangements. This could potentially have consequences if the member has valid enhanced protection or any of the fixed protections (i.e. the protection would be lost).

Please note: small pots don’t trigger the money purchase annual allowance (MPAA). 

Crystallised and uncrystallised benefit rights

Where the payment represents uncrystallised benefit rights, 25% of the payment is free of income tax, and the balance of the payment is chargeable to income tax as pension income. If the payment represents crystallised rights, all of the payment is chargeable to income tax as pension income. Where the payment represents a mixture of both uncrystallised and crystallised benefit rights, only 25% of the part of the payment relating to the uncrystallised rights can be paid free of income tax.

What is trivial commutation?

Trivial commutation is where a defined benefit pension member may commute one or more pension arrangements as long as they comply with the following:

1. the member has reached the minimum retirement age of 55, or satisfies the definition for ill-health early retirement or has a protected early pension age

2. the lump sum extinguishes the member’s entitlement to defined benefits under the registered pension scheme making the payment

3. all commutations must take place within a 12-month period from the date of the first trivial commutation payment. Any commuted lump sum paid after the 12-month period has ended won’t qualify as a trivial commutation lump sum

4. the value of all members’ rights should not exceed £30,000 on the nominated date (the nominated date can be any date within 3 months of the start of the commutation period). The £30,000 value is for all pensions, so if a client has a DB scheme valued at £29,000 and a Stakeholder Pension worth £2,000 on the nominated date then commuting the DB scheme will not be possible.

5. the member hasn’t been paid a trivial commutation lump sum previously (from any registered pension scheme), except any earlier payment within the commutation period (a trivial commutation that occurred before 6 April 2006 doesn’t count)

6. the lump sum is paid when the member has some available lifetime allowance.

If the member hasn’t previously drawn or become entitled to any other benefits under the registered pension scheme before the trivial commutation lump sum is paid, 75% of the lump sum paid is treated as taxable pension income for the tax year the payment is made, accountable through PAYE. The 25% deduction is given to reflect that, if the trivial commutation lump sum wasn’t paid and normal benefit rules applied, the member would (generally) be entitled to a tax-free pension commencement lump sum, representing 25% of the capital value of the benefits coming into payment. No extra deduction is given where the member is entitled to a pension commencement lump sum of more than 25%, due to the transitional protection of such an entitlement held before 6 April 2006.

Where a pension in payment is being commuted, or the member has previously drawn (or become entitled to) any other benefit from the scheme, but still has uncrystallised rights held in any arrangement under the scheme, 25% of the value of the uncrystallised rights may be paid tax-free. The remaining part of the payment is taxed as pension income for the tax year the lump sum payment is made. Again, this taxable income is accountable through PAYE.

Since April 2015, trivial commutation of all pension benefits has only been relevant to defined benefit pension schemes. Historically, it was also used for defined contribution schemes. However, the introduction of pensions flexibility for DC schemes after April 2015 removed the need for this option, as all DC benefits can now be accessed as lump sum (regardless of the amount).

Commutation of DB lump sum death benefit

If, on the death of a member the capital value of the following pensions is under £30,000 per scheme, a commutation lump sum death benefit can be paid instead of the ongoing pension benefit:

1. dependant / nominee / joint life pension

2. guaranteed annuity / scheme pension guarantees.

The commutation lump sum death benefit will be subject to marginal rate income tax in the hands of the recipient.

Pension guide

Pension information: guide to the basic facts.

You might have one or more different types of pension. Understanding which you have is important because it affects the decisions you need to make as you approach retirement.

• What type of pension do I have?

• Your State Pension choices

• Your pension choices if you have a defined benefit pension

• Your pension choices if you have a defined contribution pension

What type of pension do I have?

What is a pension pot?

‘Pension pot’ refers to the savings you build up in a certain type of pension known as a ‘defined contribution’ pension scheme. You and your employer (if you are employed) pay into the scheme and this builds up a ‘pot’ of money over time, which you can use to give yourself an income when you want to cut down on how much you work, or stop working altogether. It includes workplace, personal and stakeholder pension schemes.

There are three main types of pension:

• the State Pension

• defined benefit pensions, and

• defined contribution pensions

State Pension

Most people get some State Pension. It’s paid by the government and is a secure income for life which increases by at least the rate of inflation each year.

You build up your entitlement to the State Pension by making National Insurance contributions during your working life.

In some cases, you can do this even when you’re not working, such as when you’re bringing up children or claiming certain benefits.

From April 2016 a new flat-rate State Pension was introduced. For the current tax year 2019-20 the full new State Pension is only £168.60 per week.

However, you might be entitled to more than this if you have built up entitlement to ‘additional state pension’ under the old pre-April 2016 system – or less than this if you were ‘contracted out’ of the additional state pension.

To be eligible for the full State Pension you will need 35 years NI record. You’ll usually need at least 10 qualifying years on your National Insurance record to qualify.

Defined benefit pension

You’re most likely to have a defined benefit (DB) pension if you work in the public sector or for a large company. This is a salary-related pension which pays out a secure income for life and increases each year. The pension you get is based on how long you’ve been a part of the scheme and how much you earn.

You might have a final salary scheme where your pension is based on your pay when you retire or leave the scheme, or alternatively a career-average scheme where your pension is based on the average of your pay while you were a member of the scheme.

Defined contribution pension

With this type of scheme, you build up a pension pot which you can draw an income from when you cut down or stop working. But you must be aged at least 55 before you can start to take money out. With this type of pension scheme, you can usually withdraw at least 25 per cent (a quarter) of your pot tax-free.

The amount that builds up depends on:

• the level of charges you pay

• how well your investment performs, and

• how much you and your employer (if you are employed) pay into the scheme

Defined contribution (DC) pensions include workplace, personal and stakeholder pension schemes.

Your State Pension choices

You won’t get your State Pension automatically – you have to claim it. You should get a letter no later than two months before you reach State Pension age, telling you what to do.

You can also defer taking it. If you want to wait to claim your pension, you don’t need to do anything. Your pension will automatically be deferred until you claim it and will increase by 1% for every nine weeks you defer. This works out at just under 5.8% for every full year.

The extra amount is paid with your regular State Pension payment when you finally take it.

Find out your State Pension age at GOV.UK

Your pension choices if you have a defined benefit pension

Most defined benefit pension schemes have a normal retirement age of 65.

If your scheme allows, you might be able to take your pension earlier but this will reduce the pension you get quite considerably. (Typically 5% per annum)

When you take your pension you usually have the option of taking some of it as a tax-free cash sum.

How much you can take will vary depending on your scheme rules, but often you can take roughly up to a quarter of the value of your pension benefits like this.

Reducing the amount of tax-free cash you take might increase the amount of income you receive.

It is possible to transfer your defined benefit pension to a defined contribution pension which would then allow you to access your pension more flexibly.

However, consider this option very carefully as you might be giving up very valuable benefits.

Before going ahead with a transfer from this type of scheme speak to a regulated financial adviser.

Your pension choices if you have a defined contribution pension

Once you reach 55 you have complete freedom over what to do with your pension pot.

However, the longer you leave your pot to continue building up, the more money you will have to live on in retirement.

To understand the choices for using your pension pot, use could use Pension Wise – the free and impartial service backed by government or if you are still unsure of the best option for you, consider taking regulated financial advice.

Source: pensions advisory service

WINN-BROWN & CO.NOVEMBER 2, 2015

Pension planning at the end of the tax year.

As we move into the final month of the 2019/2020 tax year it is worth reminding ourselves to use up pension allowances and reliefs. Here we remind you of some of the traditional approaches. 

Utilize the annual allowance 

Despite recent cuts to the annual and lifetime allowances, pension funding is still incentivised by generous tax benefits. Tax relief against personal contributions and equivalent benefits for employer contributions represent an exemption from income tax on the segment of earnings that are directed to retirement funds. This is a significant benefit and should be fully utilised within the one’s financial means.

Each tax year, total personal contributions above £3,600 gross are restricted to relevant UK earnings; and total contributions (including accrual of defined benefits) from all sources are restricted by the standard or tapered annual allowance plus carry forward. If you have triggered the money purchase annual allowance and are therefore further restricted to total money purchase contributions of £4,000 each tax year without carry forward, you can use the remaining allowance to accrue within any defined benefit schemes.

Planning

Within the limits of affordability (and assuming the money purchase annual allowance doesn’t apply), you should top up your money purchase contributions to the lower of: 

• the remainder of your unused relevant UK earnings 

• the remaining annual allowance plus carry forward.

EXAMPLE

Adam earns £120,000 in 2019/2020. He has already paid £5,000 and benefited from matched employer contributions. He is not subject to the tapered or money purchase annual allowances and has £25,000 carry forward available from 2016/2017 to 2018/2019. 

His maximum tax-relievable personal contribution is the lower of: 

• unused relevant UK earnings: £120,000 – £5,000 = £115,000

• unused annual allowances: £40,000 – £10,000 + £25,000 = £55,000 

If he can afford the contribution, Adam should pay £55,000 gross (£44,000 net) to his money purchase pension before the end of the tax year in line with the provider’s end of tax year requirements. 

He will get 20% tax relief at source – £11,000; a further £11,000 higher rate tax relief provided that he submits a self-assessment tax return for the tax year detailing the contribution. Furthermore, he will reclaim the remaining £7,500 of his income tax personal allowance, reducing his tax bill by a further £3,000.

His effective rate of tax relief will be 45.5%.

Carry forward

 In the above example, it was necessary to work out the unused annual allowances for carry forward purposes. This allowed the unused allowances from the three previous tax years to be brought forward and added to this year’s allowance. 

For those who can pay contributions above their annual allowance for the year (including those paid by their employer), carry forward is an integral part of tax year end planning. The rules are straight forward:

• The unused annual allowance (standard or tapered) of each of the last three tax years is carried forward and added to this year’s allowance. 

• Carry forward from a particular tax year is only available if the client was a member of a registered pension scheme in that year. 

• The current year’s allowance is used first, then the allowance of the earliest available carry forward years, then the next earliest year and so on.  

• The rules for the 2015/2016 tax year, which can still be relevant, are different and are explained in our CPD Guide: The Tax Aspects of Pension Funding. 

• No formal application is required, but if the annual allowance plus carry forward is exceeded the excess needs to be noted on the supplementary self-assessment form. 

Earnings are not carried forward, so a scheme member still needs relevant UK earnings to justify personal contributions. Employer contributions, however, are not limited by earnings.

EXAMPLE

Fred is self-employed and earned £35,000 in his financial year ending in 2019/2020. He has paid no pension contributions yet this year but wants to pay a contribution of £50,000 utilising some of his unused allowances from 2016/2017 to 2018/2019. 

Whilst Fred has unused annual allowances from the three previous tax years, carry forward is not relevant for him. His maximum tax-relievable personal contribution this tax year is £35,000 gross and he cannot receive employer contributions.  

Despite recent cuts to the annual and lifetime allowances, pension funding is still incentivised by generous tax benefits. 

Reclaiming the personal allowance and child benefit

As well as building up retirement benefits in a tax-efficient way, paying personal contributions to a pension can help reclaim the income tax personal allowance and avoid the high income child benefit charge. In both instances, the underlying income measure that makes this possible is ‘adjusted net income’, which is total taxable income before deducting the personal allowance less relief at source pension contributions and gift aid payments. 

The relevant income band for the personal allowance is £100,000 to £125,000 in 2019/2020. Every £2 of adjusted net income above £100,000 reduces the personal allowance by £1. Therefore, as the personal allowance in 2019/2020 is £12,500, it is reduced to £0 when income exceeds £100,000 by at least £25,000 (2 x £12,500). 

For child benefit, the relevant income band is £50,000 to £60,000. Every £100 of adjusted net income above £50,000 of the highest earner of a couple, one of whom receives child benefit, triggers a tax charge of 1% of the benefit received. Therefore, when income exceeds £60,000 the tax charge equals 100% of the benefit received, effectively withdrawing the benefit. If child benefit has not been claimed or received (perhaps because the couple knew one of their incomes would be too high) there is no tax charge.

EXAMPLE

 Jude receives an annual salary of £120,000. In addition, he benefits from a 15% employer pension contribution of £18,000, which requires him to pay 5% or £6,000 gross.

His adjusted net income is

• Income £120,000 

• Pension (£6,000) 

• ANI £114,000 

Based on this he is set to lose £7,000 of his personal allowance. 

If Jude can afford further contributions of £14,000 gross, he will reclaim his full personal allowance. The contribution will cost him £11,200 up front, but he will benefit from higher rate tax relief of £2,800 and an income tax reduction of £2,800 (owing to the increase in the personal allowance) when his self-assessment tax return has been submitted. 

The contribution will ultimately cost him just £5,600, thus benefiting from 60% tax relief and within his annual allowance for 2019/2020.

EXAMPLE

Sadie, who receives child benefit for two children, receives an annual salary of £55,000. In addition, she benefits from a 5% employer pension contribution of £2,750, which requires her to pay in the same amount. 

Her adjusted net income is: 

• Income £55,000 

• Pension (£2,750) 

• ANI £52,250 

Her child benefit entitlement is £1,788.80 and her high income child benefit tax charge will be: 

*£2,200/£100 = 22% x £1,788.80 = £393.53

 (*every full £100 above £50,000 is included)

If Sadie can afford further contributions of £2,250 gross, she will avoid this tax charge. The contribution will cost her £1,800 initially, but she will benefit from higher rate tax relief of a further £450 and avoid a tax charge of £393.53.

The contribution will ultimately cost her £956.47, thus benefiting from 57.49% tax relief.

Source: Scottish Widows

What is the difference between independent and restricted advice?

There are 2 types of investment advice: ‘independent’ and ‘restricted’. It is also possible to obtain ‘guidance’ (or no advice).

If you are getting advice about investing your money, you need to know there are two different types of financial advisers – independent and restricted – and this can affect the advice you are given.

Some advisers can offer the full range of financial products and providers available, and are called independent advisers. But many advisers have chosen to offer restricted advice and will focus on a limited selection of products and/or providers.

All financial advisers have to be approved or authorised by the Financial Conduct Authority. Both independent and restricted advisers must pass the same qualifications and meet the same requirements to ensure they are providing suitable advice.

An adviser or firm has to tell you in writing whether they offer independent or restricted advice, but if you are not sure what they offer you should ask for more information.

Independent advice

An adviser or firm that provides independent advice is able to consider and recommend all types of retail investment products that could meet your needs and objectives.

Independent advisers will also consider products from all firms across the market, and have to give unbiased and unrestricted advice.

An independent adviser may also be called an 'independent financial adviser' or 'IFA'.

Restricted advice

A restricted adviser or firm can only recommend certain products, product providers, or both.

The adviser or firm has to clearly explain the nature of the restriction. If you are not sure you should ask for further information, but some examples of restricted advice are where:

• the adviser works with one product provider and only considers products that company offers

• the adviser considers products from several – but not all – product providers

• the adviser can recommend one or some types of products, but not all retail investment products

• the adviser has chosen to focus on a particular market, such as pensions, and considers products from all providers within that market

Restricted advisers and firms cannot describe the advice they offer as 'independent'.

Most of the larger and better-known investment houses give restricted advice. These include St James Place, Hargreaves Lansdown and Tilney. (There is also an argument that as Independent Financial Advisers (IFAs) cannot access funds managed by companies such as St James Place can an IFA in fact offer whole of market advice?)

The Financial Conduct Authority (FCA) has provided a useful checklist of key differences between independent and restricted advice for consumers:(FCA) has provided a useful checklist of key differences between independent and restricted advice for consumers: 

No advice 

No advice is often referred to as ‘guidance’, wherein a client is only given general information and must decide, for themselves, the most suitable.

About us

Whichever option you prefer we can ensure that your requirements are met as we deal with both advisers that are independent and restricted.

How will I be charged for pension advice?

Financial advisers will have different ways of charging for their services.

Advisers must agree up front how much you will be charged for their services, when you'll be charged and how payments will be made to them. There are three main ways you will be charged.  

Flat fees 

A one-off charge that covers everything from the fact find to the plan implementation. Tailored to your needs, but could vary wildly from adviser to adviser. You could be charged an initial fee for the recommendations and then a flat fee annually for reviews or each piece of work your adviser undertakes.

Hourly fees 

Simple and easily evidenced, but beware, as this method may be less of an incentive for the adviser to work quickly. You could expect to pay anything between £50 and £250 per hour. 

Proportion of the money you want to invest

This is a percentage of your assets. You could be charged an initial fee, usually ranging between 1% and 4%, and an ongoing, annual charge between 0.5% and 1.5%. Note that if you have a smaller amount to invest, an adviser who uses this method of charging might be reluctant to take you on, as they might feel the amount of revenue they would generate might not justify the cost of offering you their service.

How much does pension advice cost? 

In May 2018, Which? surveyed more than 100 IFAs to find out how they charge clients. Some 79% of firms charge up-front percentage fees based on the amount invested, 71% apply upfront fixed fees and 53% have a standard hourly rate. We also asked them to quote us on a range of retirement-related scenarios.  Pension advice about converting a £100,000 pot into retirement income costs an average of £1,837 or 1.84% of the fund value. Combining pension pots worth £150,000 and opening a Sipp incurs average fees of £2,897.

How can I afford to pay for pension advice?

 The cost of financial advice on your pension can run into thousands of pounds.  Recognising this, the pensions industry has created some alternative ways to fund the cost of pension advice without you having to find a large lump sum up front. 

The pension advice allowance

Introduced in April 2017, the pension advice allowance lets you withdraw up to £500 from your pension savings to put towards the cost of retirement and pensions advice. This £500 allowance can be used three times, so you can access retirement advice at different stages of your life. You may, for example want advice when choosing a pension, and again when you’re deciding what to do with your savings. However, you can only use one of your three withdrawals per tax year. The good news is that you won’t be charged any tax on your withdrawal, provided you use it to pay for financial advice. The pension advice allowance is available at any age, but can only be used by people who have a defined contribution pension. The scheme is not available for those that have a defined benefit, or final salary, pension. 

Employer-funded advice 

Companies can offer to pay for financial advice for their employees without paying income tax. This tax-exemption has always existed – but has been increased since April 2017 from £150 to £500. In combination with the pension advice allowance, this means you could get £1,000 towards paying for pension or retirement advice.

Source: Which?