The issue: The client, aged 63, has a number of small pension pots from a mix of occupational and personal pensions and wishes to take them potentially as a lump sum rather than purchase a small annuity. She wishes to continue working as long as possible if her health allows.
The solution: The client can potentially commute all these arrangements on the grounds of triviality as she is now aged over 60. There is no upper age limit now although there was an upper age limit of 75 before 6 April 2011.
All these benefits from the selected arrangements must be commuted and this process should be within 12 months “commutation period” from the first trivial commutation payment.
The overall value of these pensions should not exceed £18,000 (2012/13) on the nominated date, this date being any day within three months of the commencement of the commutation period.
This payment is taxed as pension income in the year it is received, 25 per cent of the payment is tax-free if the payment relates to uncrystallised benefits and the client has not drawn any benefits.
If a cash sum of more than 25 per cent of the pension value is paid, the payment will be unauthorised and will be subject to a 40 per cent tax charge on the member and other tax charges on the scheme.
Pension providers have to apply PAYE to this lump-sum payment, treating it as if it was a single weekly or monthly salary payment. This means only part of the annual tax allowances and tax rates are applied to the payment.
This invariably means that too much tax is initially deducted, particularly if the client is a non or basic-rate taxpayer.
It is possible to claim a refund of any excess tax before the end of the tax year, using a special form (P53) provided by HM Revenue & Customs (HMRC).
To support that refund, the pension provider must provide the recipient with the P45 form. As a result, getting the money back can take some considerable time for the client.
The Finance Act 2008 introduced new rules which allow small occupational pensions to be cashed in under triviality rules, even if the main rules mentioned earlier have not been met.
These include: a client must be aged 60 or over, must not be a controlling director of the sponsoring employer, the payment must not exceed £2,000, this payment extinguishes the client’s right to benefits under the scheme and there must not have been a transfer out of the scheme in the three years preceding the date of payment.
Again, 25 per cent of the payment is tax-free, with the remaining 75 per cent taxed as income.
As of 6 April 2012, the client may be able to exchange her pension benefits for cash with regards to her private pension arrangements such as Sipp, PPP, Section 32 Buyouts, etc.
This new rule allows private pensions to be cashed in under triviality rules, even if the main rules above have not been met.
The rules again include a minimum age of 60, payment not exceeding £2,000, it extinguishes all the client’s rights under the arrangement and the client has not previously received more than one payment under one of these types of schemes.
This payment can be made irrespective of the client’s overall pension benefits and can be made in addition to either the trivial commutation payment or the small occupational pension pots mentioned already.
With clients now moving from one employer to another in short spaces of time, and the imminent arrival of pension auto enrolment, the likelihood of them accumulating small pension pots increases, therefore the option to potentially commute under the grounds of triviality will become increasingly common.
Aj Somal is a chartered financial planner at Aurora Financial Planning