Cashing In On Your Pension

June 3rd, 2008

Since 6th April 2006, an individual can take all their pension benefits as a cash lump sum under the ‘trivial commutation’ rules if all of the following conditions can be met:

  • The total value of benefits under all pension arrangements, including any already in payment, is not more than 1% of the lifetime allowance (£16,500 in 2008/09)
  • The individual is aged between 60 and 75 and the lump sum is paid before their 75th birthday
  • The payment fully extinguishes all their pension rights held under the pension arrangement(s) being commuted
  • All benefits are commuted within one single 12 month period. There is no further opportunity to commute benefits on the grounds of triviality outside this 12 month period

If the benefits being commuted are not already in payment, 25% of the fund can be paid as a tax free lump sum. The remaining 75% will also be paid as a lump sum but subject to income tax.  In contrast, if the benefits being commuted are already in payment, the whole amount will be taxed.

In a welcome move however, the Government has recently confirmed that it will introduce legislation in the 2008 Finance Bill to enable an individual to take ‘stranded pots’ held under an occupational scheme as a cash lump sum on the grounds of  triviality, as long as the value of those benefits are below £2,000.
The regulations will define the meaning of ‘’stranded pots’’ and spell out the particular circumstance in which these can be commuted, although the 2008 budget notes confirm that these payments will be in addition to the normal 1% of standard lifetime allowance limit (£16,500 in 2008/09).
Where partial transfers are allowed under an occupational scheme the Government fears that people will transfer enough of the fund to leave £2,000 under the scheme and then claim under the ‘stranded pot’ trivial commutation rules.  They therefore intend to introduce further, as yet unclarified, restrictions to counter this.

The rules differ where an individual’s pension benefits are commuted on the grounds of serious ill-health.  Serious ill-health is where life expectancy is less than 12 months.  Since 6th April 2006 it is possible to commute benefits on serious ill-health from all registered pension schemes including personal pensions and stakeholder pension plans.

Commutation on the grounds of serious ill-health is only available where benefits are not already in payment and where:

  • The individual’s lifetime allowance (the maximum amount of pension savings that can benefit from tax relief – £1.65m for 2008/09) has not been exhausted.
  • The payment is made before age 75 (there is no minimum age).

Confirmation must be obtained from a registered medical practitioner that life expectancy is less than 12 months before the scheme pays the ‘serious ill-health lump sum’.  If medical evidence is not obtained before commutation of benefits there may be a punitive tax charge.
When benefits are fully commuted on the grounds of serious ill-health they are tested against the available lifetime allowance to ensure that they are within this limit.  Once tested there will be no tax liability on the proceeds as long as the amount payable is within the individual’s available lifetime allowance.

In 2006 the Department for Work and Pensions (DWP) confirmed that serious ill-health commutation would be allowed for contracted-out rights, but excluding any entitlement to a survivor’s pension.  This means that where benefits have been accrued from contracting out of the State Earnings Related Pension Scheme (SERPS) or the State Second Pension (S2P) – where a survivor’s pension must be provided for, and the individual is married or has a civil partner, 50% of these rights must be held in a separate arrangement to provide a survivor’s pension.

The levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.