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

There's no such thing as free pension advice

There is no such thing as free pensions advice.

Almost five years on from when the Government introduced the new pension freedom legislation and it is still difficult to know how things are going.

This has meant that anyone who wants to blame the freedoms for consumer harm can do so.

Last month, the Financial Times published a story based on a freedom of information request about those who had cashed in final salary pensions since 2015.

It found concerns about 80 per cent of the companies providing bad advice in this £80bn market. As a result, the Financial Conduct Authority planned to write to 1,841 financial advisers about potential harm in their advice. 

The estimable Mick McAteer, formerly of Which? and an ex-FCA board member, demanded a full-scale inquiry.

It came in the same month that the FCA admitted too much transfer advice was not at an acceptable standard.

The FCA’s intervention, in its letter to chief executives of financial advice businesses, should be taken with deadly seriousness.

It is clear from the tone of that missive that the FCA has advice companies in its sight – just at a time when the burden of regulation is already at its most choking.

It was interesting to see it positively demanding advisers turn in criminal or rogue businesses – a call I have been making for some time now.

Let’s hope that means good advisers turning the table on introducers and ending all ties with them.

But what are we to make of all this in the context of the pension freedoms?

Are mis-sold pension transfers to blame; is it criminal activity or poor advice; is it reckless consumers; is it contingent fees; was it the fault of the media for cheerleading the death of the freedoms; or is it driven by trustees desperate to reduce their liabilities?

Sadly, it is impossible to know, even though 160,000 people could be affected. 

The key argument against the pension freedoms seemed to be that consumers are fundamentally too stupid to be able to make their own decisions. It is certainly true that most will underestimate their own longevity.

We were told that everyone would gamble their money; if anything, the tentative findings we have already had from the FCA show that people are not taking enough risk.

We know that lots of people have cashed in pots, but any evidence that this only applies to smaller pensions is scant.

It may be the case that many should be taking annuities, but we do not know for sure.

And it is certainly true that when the pension freedoms were launched, the industry was utterly unprepared. 

I have seen arguments for minimum income requirements before people can access the pension freedoms, or that some sectors of the economy could be barred.

All that would do is make freedom a right of the rich – and that is clearly not good.

The freedoms are a great act of consumer empowerment, but having launched them on the public, the Treasury and the FCA should now launch a study into their effects so that we have a full picture of how people are behaving and the advice companies are giving.

It would not be fair for advice companies to bear the brunt of increased scrutiny without greater evidence of what actually has happened since 2015.

Whoever the permanent boss of the FCA is, he or she should make a full assessment of the pension freedoms one of their top priorities.

Source: James Coney is money editor ofThe Times and The Sunday Times@

Pension options at retirement

At retirement when we take our pension from a defined contribution scheme we have a number of options available to us.

• The open market option

• Tax free cash lump sum

• The frequency of payment

• Escalation in payments

• Spouses provisions

• Guarantee periods

Each of these options can be taken in conjunction with any other. However, some of the benefits will defray the initial amount of pension benefit that you would receive should you take a single life pension with no other provisions.

The Open Market Option

The Open Market Option (or OMO) was introduced as part of the 1975 United Kingdom Finance Act and allows someone approaching retirement to ‘shop around’ for a number of options to convert their pension pot into an annuity, rather than simply taking the default rate offered by their pension provider.

 The term OMO is now generally used to support a campaign, often led by the pensions industry and the media, to make sure people know the benefits of shopping around. The majority of people still don’t use the Open Market Option in large part because they don’t know they can or don’t realise the benefits of doing so. Retirees who don’t use the OMO and settle for the default deal offered by their pension provider, may be missing out on up to 20% more income from an annuity. This is especially important as retirees cannot change their annuity once it has been purchased.

 One of the main reasons that people can get more from an annuity if they shop around is that they may qualify for what is known as an Enhanced Annuity (sometimes known as an Impaired Life Annuity) which pays a higher income to people who suffer from a range of health conditions – anything from asthma to a serious heart condition. There are also other products available that may suit peoples retirement needs better than the default deal offered by a pension provider. One suggestion to make the most of the Open Market Option is to speak to an independent financial adviser who will explain the different options available at retirement.

Tax Free Cash Lump Sum

At retirement you are permitted to take 25% (a quarter) of your pension fund in as a Tax-Free Cash Lump Sum. In certain circumstances it could be more than this. The Tax-Free cash can be paid by the ceding scheme or the new scheme should you take advantage of your Open Market Option. The remainder will be considered as earned income by HMRC. The amount of tax you pay will depend on your prevailing tax status at the time that you take the pension.

Frequency of Payments

Most pension providers will allow you to take your pension at different Frequencies of Payments, such as annually, quarterly and monthly, sometimes in advance or arrears. Once you have made your decision that is generally how you will continue to receive your income for the rest of your pension annuity.

Escalation in Payment

You can elect to have your pension paid to you at a flat rate for the rest of your life or have it increase in different ways, through Escalation in Payment, typically by 5%, 7.5% etc. Should you choose this option then the initial pension you receive will be significantly reduced but at least you can ensure that your pension retains some degree of inflation proofing. 

Spouse’s Provisions

Typically people will purchase a single life annuity but you can elect to provide a pension for your spouse, through a Spouse's Provision should you wish to do so. This at least ensures that should you die in the short term your spouse will continue to benefit from your pension. Spouses pensions can generally be provided at different rates as a percentage of your own, for example 33%, 50% or even 100%. As with all other pension options its best to check what the pension provider is able to offer.

Again this particular option does reduce the amount of initial pension annuity because you are effectively buying two pensions from the same amount of money.

Guarantee Periods

At outset, as with all these options you can elect to take a guarantee period against the pension. 

A Guarantee Period can be of different duration, again typically 3, 5 or 10 years. This means that the pension will be paid out to your spouse (or in the event of your spouse predeceasing  you, your estate) for the remainder of the term should you die within the guarantee period. For example if you were to take a 10 year guarantee period and then die in year 6 your spouse (or estate) would continue to receive the pension for the remaining 4 year term, after which time, (unless you had provided for a spouses pension) the pension would cease and no other payments would be made.

These options are not offered at the outset of your pension plan as you have no indication at that time what your marital status may be at the time of vesting, the prevailing rates of inflation and your need for tax free cash. Nevertheless the decisions that you make in relation to these options are of great importance both to you and your family should you have one. Moreover once you have made your decisions they cannot be unwound, there are no “U turns”. It is therefore essential that you give consideration to taking professional financial advice at this pivotal and critical time in your financial planning.

The money advice service

The Money and Pensions Service is an organisation whose statutory objective is to develop and co-ordinate a national strategy to improve people’s financial capabilities. The service provides free money guidance and debt advice online and by telephone…… read more