People aged over 55 who have only a small (less than £30,000) pension pot in a defined benefit (final salary) scheme or in some instances in a defined contribution scheme paying only a small pension – but not where the pension pot has been used to buy an annuity – can normally cash in such schemes, taking the entire pension pot as a lump sum under the 'trivial commutation' and 'small pots' rules, which were introduced a few years ago.
The Low Incomes Tax Reform Group (LITRG) has published a guide which outlines the rules which apply in such cases.
In simple terms:
- Any pension fund cashed in has to be taken in its entirety and funds can be cashed in 'one by one' if wanted;
- Under the trivial commutation rules, the last encashment must take place within 12 years of the first; and
- Other pension pots of less than £10,000 in value may be able to be cashed in also.
However, when a pension pot is taken as a lump sum, 75 per cent of the sum taken is regarded as income for the purposes of calculating tax credits, and the lump sum released will no longer be disregarded (as pension funds are) in the calculation of means-tested benefits.
Also, a pension fund can in some circumstances be passed directly to a beneficiary if untaken and will thus not be included in your estate for Inheritance Tax purposes. Once the pension pot is turned into cash, this is no longer the case. For more information on this, see the Pension Wise website.
The LITRG has a web page which gives advice to pensioners on common tax issues they face, and also publishes periodic updates, such as recent guidance on the new state pension scheme.