The government recognises that individuals with very small pensions should be allowed to cash-in the whole fund as a lump sum. This is commonly known as “commutation on the grounds of Triviality”.
Normally pension rules dictate you can only take 25% of your pension fund as a cash lump sum and the balance must be used to provide you with an income for life. However; in the case of very small “trivial” pension funds this may be a minimal income.
To illustrate what this really means, rather than receive a gross pension income of £200 paid every year, you could take the fund as a cash lump sum and be paid a gross amount of £3,773 as a one off payment instead *. What would you prefer?
The basic terms you must comply with are:
1. You must be aged 60 or over
2. The total of all your pension rights do not exceed £18,000 (if you have more than one pension, the combined funds must not exceed this limit)
There is no upper age limit as this was removed in 2011.
The threshold is announced each year by the government and is £18,000 for 2012/13. It used to be based on what was known as the lifetime allowance, however; this link was removed from 6 April 2012.
If you have more than one pension to cash-in, the maximum delay before you must cash-in the other one is 12 months. After this time period the option expires.
You are allowed to receive a lump sum equal to 25% of your pension fund tax free, the remainder is treated as taxable income in the year you receive it. Potentially it is possible you won’t have to pay any tax.
Defined Contribution Pension Plans – personal pensions, stakeholder, sipps, group personal pensions, retirement annuity contracts, section 32 buyouts, occupational money purchase schemes etc.
These are pensions that provide benefits based on the build-up of a “pot” of money.
In addition to the current figure of £18,000 being taken as a cash lump sum, if you have very small pots of £2,000 or less, these can be released in their entirety as well, however; you are limited to only being able to do this twice i.e. no more than 2 funds of this very small amount can be taken.
Defined Benefits Schemes – final salary, local government etc
These are pension schemes set up by an employer to provide retirement benefits for an employee. At retirement you receive a pension based on your number of years’ service and salary, typically expressed as 1/60th of your salary for each year served.
You are only allowed to take advantage of triviality payments from these types of schemes if the schemes rules actually allow it, they may not. If the rules don’t allow Triviality it may be possible to transfer that pension to an arrangement that will.
Because these scheme don’t have a pot of money specific to the individual, to calculate whether Triviality rules apply you have to make a calculation based on a multiple of the pension income you would have received.
The calculation is 20 times the pension plus any separate lump sum.
*Figures assume a male aged 60 who purchases a single life annuity, paid monthly in advance, guaranteed for 5 years and level in payment. Based on an annuity rate of 5.3%, which was available in February 2012.
For more information, please read the Grove Pension Triviality Guide