New tax-break on small pensions
Retirees with very small amounts of money in occupational pension schemes will be able to take out up to £2,000 tax-free under new rules announced in today’s Budget.
Individuals over the age of 60 can get this lump sum even when receiving an income from another larger pension fund. The new rules will look at each occupational scheme in isolation.
Since April 2006, the triviality rules have allowed individuals to take the total value of their pension pot if it comes in at less than 1% of the lifetime allowance - £16,000 in the current tax year rising to £16,500 in April.
But because all pension pots are taken into account, individuals can be left with very small amounts in one fund. For example, if someone has a final salary benefit of £15,000 and benefits in an occupational defined contribution scheme of £2,000 then these collectively exceed the £16,000 threshold.
The individual can withdraw 25% of the £2,000 in the occupational scheme as a tax-free lump sum but they will then have to buy an annuity with the remaining amount, which will be taxed as income. However, the £1,500 is also below the minimum annuity price of many providers.
Andrew Tully, senior pensions policy manager at Standard Life, said: "Forcing people to buy annuities with very small pension pots means they don't receive good value for money. Allowing small pension pots to be paid as a lump sum even though people may be receiving income from other, larger, pensions is excellent news for consumers."
Rachel Vahey, head of pensions development, at AEGON, said: "It makes sense to introduce an extra trivial commutation limit for small pension pots and the news on ‘stranded pots is welcome’. But the new £2,000 trivial commutation limit shouldn’t just apply to occupational pensions schemes. This just serves to create and uneven playing field between personal pensions and occupations pension schemes at a time when the focus is on personal accounts and the role they will play in boosting pension saving.
"It’s more likely small funds will build up under personal pensions as the preservation rules allow many occupational scheme members to take a refund of contributions if they leave within two years.
"A-day was supposed to remove the anomalies between different types of pension schemes. Creating new rules which will only apply to one type of scheme is a highly unwelcome step backwards."
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Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.