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Trivial pursuits

Those seeking financial advice as they approach retirement will generally have a substantial pension provision built up and the challenge is to find the best way of using it to provide an income. However, advisers will occasionally come across clients with very little invested in a pension, perhaps because their assets have come largely from an inheritance or they have been a non-working spouse for many years.

For such clients, the pension triviality rules could help release a capital amount as an alternative to them receiving a very small income for the rest of their lives.

These rules have recently been relaxed in certain circumstances.

Since April 2006, it has been possible to commute pensions totalling up to 1 per cent of the lifetime allowance, which means a maximum of £17,500 in the current tax year.

This calculation must include all of the client’s pension funds, and all the pensions must be commuted within a 12-month period after the client reaches age 60 and before the age of 75.

Both pre- and post-retirement benefits can be paid out, although insurance companies may not be willing to commute annuities already being paid.

If the pension commencement lump sum (tax-free cash) has not yet been paid, 25 per cent of the payment is tax-free and the remainder is taxed under PAYE. This will be under an emergency tax code, so it is likely there will either be additional tax due or the need to claim a refund.

Recent regulations made under the Finance Act 2008 allow small pension pots to be commuted independently of the main triviality rules.

The most significant provision allows amounts of up to £2,000 in a public sector or occupational scheme, but unfortunately not in a personal pension, to be paid as a cash sum if it uses up all the benefits due under the plan.

Again, this is only available between ages 60-75 and the tax position remains the same as under the general triviality rules.

A number of other situations are also covered by the new regulations, all with the same £2,000 limit. These include where a pension scheme receives additional contributions after settling a claim, where there is a payment under the Financial Services Compensation Scheme and where a scheme member could not be traced before age 75 but is subsequently found.

The sums involved in trivial commutations are by definition small, but there is still considerable potential for advisers to add value.

Clearly, this comes largely through identifying where there is potential to take advantage of the rules and of guiding clients through the process. In particular, it may involve ensuring that encashment of very small occupational pensions under the new regulations are completed before starting the 12-month period under the existing rules.

However, in many cases the greatest potential may be to manage the timing of claims to minimise the client’s tax liability. For example, it may make sense to defer claims until the client has retired and is less likely to be subject to higher-rate tax, although some care is needed if the client is receiving pension credit benefits that could be reduced by an increase to capital.

It might also be beneficial if the 12-month window for trivial commutation can be spread over two tax years, perhaps enabling the client to stay clear of higher-rate tax.

Trivial commutation is unlikely to be a particularly lucrative activity for advisers unless it is connected to advice on more substantial assets, but clients will really appreciate being steered through the process in a way that maximises the amounts commuted and minimises the tax liability.

Ian Naismith is head of pensions market development at Scottish Widows

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