The example of one pensioner recently featured the Telegraph, who has a pension of just 24 pence per month is perhaps an extreme case, but for many people, a lump sum of a few thousand pounds when they retire, will be more useful than a tiny annual income.
There has always been a ‘triviality rule’, which allowed people with very small pension pots to take the whole fund as a lump sum. However, the rules were complex restrictive, which means the new rules announced in the last Budget, will be welcomed by many people.
How will the new rules work?
Unless they are amended, new rules will be implemented in two phases:
- Up to 5th April 2015
- From 6th April 2015
What happens if I am retiring before April 2014?
The Budget introduced some temporary rules for those people with small pension pots who are retiring before April 2015.
‘Trivial commutation’ Under the previous rules if you wanted to take your pension as a lump sum, all your pensions, when added together, had to be worth less than £18,000; this has now been increased to £30,000, excluding ‘stranded pots’.
To qualify for trivial commutation you need to be at least 60 years old.
‘Stranded pots’ Even if you have more than £30,000 in pension savings, provided that benefits are taken in the correct order, and are structured in the right way, you may still be able to access smaller, or ‘stranded’ pension pots. From 27th March, if you are 60 or over you will be able to take up to three Personal Pension pots, worth up to £10,000 each, as a lump sum.
In both cases 25% of the pension pot will be available as a tax-free lump sum, with the remaining 75% added to your income and subject to tax.
Any stranded pots of £10,000 or less would need to be taken before triviality on the main pots to get the maximum effect. If total remaining pension rights, after eliminating any stranded pots, are worth less than £30,000 these can then be paid as a lump sum under the new triviality rules.
How will it work after April 2015?
The first thing to make clear of course is that these are currently just proposals and could be altered before they are introduced. However, if they are introduced as proposed they will certainly simplify a complex set of rules.
The new triviality rules will have no effect on most Defined Contribution schemes, such as Personal Pensions, Stakeholder pensions, Self-Invested Personal Pensions (SIPPs) as pensioners will have full access, with no limit to the amount they take, from the age of 55.
It is worth remembering though that only 25% of the pension pot will be available tax-free. The remaining 75% will be added to your other income in the tax-year the lump sum is taken and then taxed at a rate of 20%, 40% or even 45% for those people taking large lump sums.
Furthermore, access will be allowed from age 55; at present triviality is only available from age 60.
However, for Defined Benefit schemes, often known as Final Salary pensions, the £30,000 triviality limit and the £10,000 occupational stranded pots limit from age 60 will still be applicable.
Who won’t these rules apply to?
If you have already bought an Annuity with your pension pot, or started taking an income from a Defined Benefit or Final Salary scheme you will not be able to benefit from these new rules.
To take a lump sum under the trivial commutation rules you will need to get the agreement of your pension provider; not all allow this option.
Finally, if you are a member of company or public sector pension scheme and you wish to take a lump sum from a pot worth less than £10,000, you may be able to do this if you meet the following conditions:
- You must take all your pension pots with the same pension scheme as a lump sum
- You can’t have transferred any funds out of the pension scheme in the last three years
- You must not be a ‘controlling director’ – or someone connected with a controlling director – of an employer that participates in the pension scheme
- You belong to more than one company or public sector scheme for the same job and your total pension pots are worth £10,000 or less
If you meet the first three conditions but not condition four you may still be able to take the whole pension pot as a lump sum but would need to check with the scheme administrator.
What are the advantages of taking a lump sum instead of an income?
- A lump sum of a few thousand pounds may be more useful than a relatively small income, especially if you already have other sources of income which meet your outgoings
- A lump sum could be used to repay debt or perhaps an interest-only mortgage
- Taking a lump sum is potentially a simpler solution that buying an Annuity or an alternative retirement income product and will may save on the cost of advice
And the disadvantages?
- Taking the lump sum will reduce the income you have in retirement
- Taking the lump sum may mean a higher Income Tax bill compared to the alternative option of taking an income
- You will be taking money out of a plan which grows tax-efficiently
Confused? Need help?
The old triviality rules were complex enough, we now have a set of temporary rules and a set of proposals which should become rules, but could be changed, before April next year.
We don’t blame you for being confused!