Many people are unaware that they can cash in small pension pots. If you are unsure about the small pot pension rules, regulations and tax issues, this blog will help to throw some light on the subject.
If you would like help with getting your retirement planning right, we at Moneyfarm are here for you. Depending on your age, retirement might seem a long way off. However, more people are now asking about how to retire at 55 and we can help you with that.
The main focus of this blog is cashing in small pension pots. If you would like a more general pension guide, please click here.
|🍯 What is a small pension pot?||A pension pot of £10,000 or less|
|🤑 How many times can I take out a 25% tax-free lump sum?||Once, for each pension pot|
|❓ Are small pension pot funds taxable?||Yes, they are|
|❤️ Types of small pension pots rules?||•Small lump sum rules|
•Trivial commutation rules
Workplace Pensions can Generate Several Small Pot Lump Sums
To make sure people started saving for their retirement in good time, between 2012 and 2017, the government introduced auto-enrolment to a workplace occupational pension for anyone earning over £10,000 per annum.
While the scheme is very beneficial, if you change employers throughout your working life, it can lead to you ending up with several small pot lump sum caches. So, it can not only get quite messy, but it might also mean your retirement money is not working as well for you as it might.
This blog will explain the small pots pension rules 2021 and how you can go about cashing in small pension pots under 55. It may also interest you to read about pension transfer as a way of realigning your pension options.
What is a Pension Pot?
Pension pot is the term used to describe the total value of pension contributions that you and, in many cases, your employer have paid into a pension scheme to help fund your retirement. This “pot” also includes any capital growth the contributions had earned dependent on the structure of the fund when it was set up.
Pension pots (you can have any number) do not include the state pension you are due to get from the government upon your retirement.
Your pension fund provider should provide you with an annual pension statement indicating the size of the pot. In addition, some providers allow you to check the value on their websites.
If you have more than one pot, you will have to get in touch with each fund provider for a statement relating to that specific fund.
Is it Possible to Cash in Small Pension Pots?
Yes, it is possible to cash in small pension pots. There are two sets of rules that can apply depending on the circumstances. They are:
- The small lump sum rules
- The trivial commutation rules
We will take a short look at each in turn
Small Pots Rules for Pensions
Taking small pension pots is permissible if you are aged 55 or over and the lump sum in question is no more than £10,000. If we are talking about personal or stakeholder pension schemes, you can take three such lump sums in your lifetime. There is no ceiling on the quantity of unrelated occupational pensions that you can commute in this way.
Trivial Pension Rules
If you are aged 55 or over, the trivial pension commutation rules permit you to take no more than £30,000 worth of pension rights from a defined benefit pension.
So, in theory, if you were to take your three small lump sums of up to £10,000 first, and your remaining defined benefits scheme rights total £30,000, you could also take those funds out, giving you access to up to £60,000 in total.
There is one important provision, however. The 12 months rule that applies to the trivial pension pot withdrawal rules. If you’re cashing in small pension pots from several funds, the withdrawals must be made within 12 months of the date of the first encashment.
Are Small Pension Pot Funds Taxable?
Unfortunately, cashing in small pension pots has tax implications. It is considered income and could therefore be liable for income pensions tax during the tax year it is encashed. The usual tax bands apply. Any small pension pot cash-in that tips the scales over the £12,570 basic tax annual threshold will attract income tax.
Does the 25% Pension Pot Withdrawal Tax-Free Rule Apply Annually?
It would be nice if it did, but unfortunately, it doesn’t. You cannot take 25% tax-free cash every year. You are only entitled to a 25% commuted lump sum from each pot once and once only. After that, you can take smaller amounts each year tax-free, but as soon as the total you have withdrawn reaches 25%, anything after that, you will have to pay tax under normal income tax band rules.
But on the plus side, although the remaining 75% of your pot(s) will be considered as taxable income, you don’t have to pay National Insurance. You stop paying NI contributions when you reach the state pension age.
Can You Cash in a Small Pension Annuity?
If you have a very small annuity, under £10,000 in value, it is possible to cash it in, but only if your fund provider permits you to do so.
Can Your Cash in Small Pension Pots before 55?
The only circumstances when taking small pension pots is permissible before you reach 55 is if you have been diagnosed with severe, debilitating ill health or a terminal illness.
In addition to state and workplace pensions, there are many ways on how to invest money for your retirement. It is a complex subject, and you are best talking to an experienced financial adviser specialist like Moneyfarm.
As well as offering you the best guidance on which type of personal pension would suit you best, we can also advise you about cashing in small pension pots, trivial commutation lump sum etiquette, and the small pot lump sum rules.
Our aim is to make sure that when you reach retirement age – whenever that might be – your personal pension will afford you the lifestyle to which you aspire.
What’s a small pension pot in the UK?
A small pension pot is a pension of £10,000 or less.
Can I take my small pension pot in a lump sum?
Yes, you can take the total amount of £10,000 as a ‘small pot lump sum’. You can take out a total of 3 small pot lump sums worth £10,000 each from non-occupational pensions in your lifetime.
Is it worth combining small pension pots?
Yes, it is worth combing small pension pots. If you consolidate your small pension pots, you can manage and monitor investments easily. You also save money on charges such as administrative fees.
*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.