Cash clinic: Make the most of a small pension pot with careful planning

Q MY WIFE, who is 66, recently retired from a part-time job where she built up a pension fund of nearly £17,000. She has been advised by the fund that the first 25 per cent of the fund value will be tax-free and that she will have to pay income tax on the balance – this will amount to almost £2,500.

Is it possible to mitigate this tax liability in any way, as it seems a high penalty for someone who has tried to save for the future? My wife has also been informed that she could opt to take the pension fund in regular instalments – is there any benefit in this? She has two other small part-time jobs so is likely to use up most of her tax-free allowances.

DF Edinburgh

A PENSION triviality rules can be utilised for people aged 60 and above who have an overall pension fund of less than £18,000. Instead of a lifetime pension income, which in your wife’s circumstances is likely to be less than £1,000 gross a year, she could draw all her accrued pension fund as a lump sum.

Provided no benefits have yet been taken, the first 25 per cent of her fund would be paid tax-free, but the balance would be taxable as earned income. I note your comments about the potential tax liability being somewhat penal in her circumstances, however, HMRC is essentially only recovering tax relief already enjoyed on contributions made to the pension. There is little that could be done to mitigate this liability, other than perhaps delaying the exercise of the commutation option until a tax year where her earned income has reduced, for instance after she retires from her other jobs.

A triviality payment must represent the entire accrued pension fund with a pension provider and must fully discharge their liability. Where the pension fund is split between more than one provider, trivial commutation payments must be fully taken across all providers within a single 12-month period. After this, the option cannot be used again, even if your wife makes further pension contributions, for instance through one of her continuing employments.

There are also special triviality rules that can be used for small “stranded” pension pots of £2,000 or less. Small pension funds of this nature can easily accrue where an individual changes jobs frequently, or perhaps in your wife’s circumstances if she has received or made pension contributions in respect of her part-time employments. Such pots would be impractical to produce a pension and so can be commuted for a lump sum.

This form of triviality commutation is available in addition to the main form detailed above and the amounts commuted do not form part of the overall £18,000 limit. The tax treatment is the same, with 25 per cent being tax-free with the balance being potentially taxable as earned income.

Whether and at what rate tax is payable on pension income in the future would depend on her total taxable income and the level of her personal allowance. Her tax position may improve when she retires from the other employments, making a modest pension income more attractive.

I would suggest that she seeks independent financial planning advice so that she may establish how best to proceed.

• Stephen Hall is a wealth manager at Cornerstone Asset Management LLP. If you have a question you need answered, write to Jeff Salway, c/o The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: [email protected]

• The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and Cornerstone Asset Management LLP accept no liability on the basis of this article.