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Trivial commutation and small pots: Then and now

This article is part of
Guide to Trivial Commutation post-Budget

Pre-Budget, the maximum value of a pension that could be trivially commuted was £18,000 (or 1 per cent of the 2011 to 2012 lifetime allowance of £1.8m).

Before the Budget, Andrew Tully, pensions technical director of MGM Advantage, says the rules for trivial commutation were complex and differed between personal pensions and occupational pensions.

The broad position meant if someone was aged between 60 and 75 and their total benefits across all schemes were valued at less than £18,000, then they could be paid wholly as a cash sum. In line with general rules, 25 per cent could be paid tax-free with the remainder taxed as income.

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As well as the triviality rules above, there were separate small pots rules that allowed a pension pot to be cashed in without reference to benefits built up in other schemes. Benefits in a single pot needed to be worth less than £2,000.

For personal pension schemes this rule could only be used twice, but there was no limit on the number of occasions it could be used with occupational schemes. Again 25 per cent was paid tax-free with the remainder taxed as income.

At the Budget, the trivial commutation limit was increased to £30,000, increasing the number of people who could take advantage of trivial commutation.

Post-27 March 2014 and until full freedom of access to pensions is granted from next April, members can therefore trivially commute pensions for lump sums if their aggregate benefits are less than £30,000.

For small pots the size of a pension that can be taken has been increased from £2,000 to £10,000 regardless of total pension wealth, with people being able to cash in up to three pots within the personal pension regime, up from two previously.

The taxation position remains the same, so 25 per cent of the trivial payment is tax-free with the remainder subject to income tax at the individual’s highest marginal rate. Existing conditions also remain, for example, people must be at least age 60 to use trivial commutation.

The complex rules around when pensions are valued also remain. This means for defined contribution pensions the value of the fund on the day of test is used.

Defined benefit pensions are valued by multipying the accrued pension (for example, no reduction for early payment) by 20. This will not be the lump sum paid as this will depend on the scheme’s conversion basis.

David Brooks, technical consultant at Broadstone Corporate Benefits says after the full Budget flexibilities come into effect next year, the triviality rules will only apply to benefits held in DB schemes.

The new trivial commutation rules and the small pots rules introduced in this year’s Budget are mutually exclusive. A client can commute benefits under a single scheme if the small pot rules are met and you can commute benefits under all schemes if the trivial commutation rules are met.

According to Ms Mitchell, head of UK administration operations at JLT Employee Benefits, it is possible to combine the rules to maximise commutation opportunities.