New rules to break open pension pots

Savers will be able to convert ‘trivial’ holdings into cash lump sums, writes Jeff Salway

THOUSANDS of savers are to be given new freedom to convert small pension pots into cash lump sums next year, under new plans set out by the government. The proposals will benefit thousands of people with decent-sized pension entitlements but holding individual pots worth less than £2,000 and who currently have few options open to them.

However, advisers urge those tempted to cash in their “trivial” pension holdings to tread carefully or risk losing out on valuable benefits.

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In draft Finance Bill legislation published last Tuesday, the Treasury signalled a rule change allowing people to access small personal pensions through lump sum payments, rather than having to use the money to buy an annuity at uncompetitive rates.

The extra flexibility will come into force on 6 April, 2012. It will affect some 25,000 savers aged 60 or over with total pension rights valued at more than £18,000 but also holding one or more personal pension pots worth less than £2,000, provided they are not already in an income drawdown arrangement. As it stands, they must convert any small pension funds into an income by purchasing an annuity. Only those who have less than £18,000 in total pension entitlements can take small personal pension holdings as cash, under the current “trivial commutation” rules.

Pension pots of less than £2,000 built up in occupational schemes can also be cashed in, under regulations introduced in 2009.

The lifting of those restrictions means savers with total pension entitlements worth more than £18,000 can take up to two pension pots of less than £2,000 as cash.

The amendment will take the pressure off annuity providers, for whom small pension pots are not profitable, and give savers a better deal for their money.

Mark Christie, a director of Edinburgh-based Carbon Financial Partners, said: “A pension pot of £2,000 could generate an income of as little as £6 to £8 per month, which won’t be of any real benefit to someone.

“Having access to the fund as a lump sum would be far more beneficial, allowing something meaningful to be done with the money.”

Cashing in small pension pots is known as trivial commutation, but until now it was limited to those with total pension savings below £18,000 (amounting to less than 1 per cent of the lifetime allowance, currently £1.8 million). The lifetime allowance falls to £1.5m in 2012-13, but the triviality limit will remain at £18,000, as the link with the allowance is to be broken.

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That suggests the rule change coming into force in April may particularly benefit higher-rate taxpayers, according to Neil Lovatt, sales and marketing director at Scottish Friendly.

“The government’s schizophrenic policy towards pensions over the past 35 years has left many people with tiny pension pots from a variety of employers that few life companies want anything to do with,” he said.

“So this is a welcome piece of flexibility, but it will be interesting to see if anyone tries to exploit the flexibility as it’s not a bad way to reduce your tax bill if you are a higher-rate taxpayer and likely to become a lower-rate taxpayer after retirement.”

However, the extra freedom over small pension pots could boost savers who want to go into income drawdown, according to David Gow, a financial planner at Acumen Financial Planning in Edinburgh.

“Amalgamation could be fruitful in helping those who are just short of the minimum income requirement of £20,000 a year to qualify for new ‘flexible drawdown’ rules, whereby you can take as much income as you want from your pension fund,” he said.

“These new rules are very welcome, but we shouldn’t lose sight of the fact that a pension pot is designed to provide an income in retirement until you die. Paint a picture of your ideal future and seek advice to devise a plan for that future.”

Advice is highly recommended whether it’s personal or occupational pensions you’re thinking about cashing in, given both the complexities and the costly consequences of making the wrong decision.

This is especially the case where occupational final salary benefits are concerned.

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For example, many older contracts contain guaranteed annuity rates that will be several times more valuable than the rates available from annuities now, which are at record lows and falling.

Some company plans may also include more generous tax-free cash allowances, having been written before the tax-free cash maximum of 25 per cent was imposed in 2006. Similarly, some people who contracted out of the state earnings-related pension scheme prior to 1988 may be entitled to valuable inflation-linked increases.

The new flexibility may encourage more people to seek out personal pensions they’ve lost track of. More than £3 billion in pension benefits remains unclaimed, according to the Unclaimed Assets Register, with thousands of people failing to vouch for small personal and occupational pension pots. If you think you may have unclaimed personal or company pensions lying around somewhere, contact the government’s pension tracing service on 0845 600 2537.

Consolidating your pensions into a single, bigger pot may be worth considering even if you’re several years away from retirement.

A 2009 survey by Edinburgh-based Aegon found nearly half of working Scots had accumulated several pensions during their careers, with almost a fifth having three or more pensions from different employers.

But having several different pensions is costly and makes it difficult to monitor performance – meaning you could be paying over the odds for poor investments.

Rolling all your pensions into one plan should be fairly simple, but the benefits could be big.

Getting rid of all the paperwork and knowing your money is in one place creates both space and peace of mind. It also makes it easier to check the value of your investments and keep an eye on their performance. One plan also costs a lot less in charges than holding three or four separate ones. That will particularly be the case if you hold pensions that are more than a decade old, as newer plans are typically cheaper. The benefits of consolidating should become clear when you come to buy an annuity as the bigger pot gives you a better chance of being offered a good rate.

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But tread carefully if you do consolidate your pensions. Check for any exit or transfer penalties that could eat into or erode the gains made from switching and look closely at the charges levied in the new plan. Above all, seek the guidance of an independent financial adviser, preferably a fee-based planner with experience of pension transfers.

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