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How do I cash in my small pension (Trivial commutation)?

Many pension providers offer the opportunity to convert 100% of a ‘small’ pension into a one-off cash payment. This is known as ‘trivial commutation’ and the cash received as a trivial commutation lump sum.

We set out the rules and issues to consider in relation to trivial commutation in this section.

What is cashing in my small pension (‘trivial commutation’)?
What are the three rules of trivial commutation?
Can you explain the £30,000 limit?
Are any additional payments allowed within the same tax rules?
Do I have to pay tax on trivial commutation lump sum payments?
How do I claim a refund from HMRC?
Are there any other issues I need to consider?
Examples
Where can I find more help?


What is cashing in my small pension (‘trivial commutation’)?

Many pension providers offer the opportunity to convert 100% of a ‘small’ pension into a one-off cash payment. This is known as ‘trivial commutation’ and the cash received as a trivial commutation lump sum.

25% of the value of most pension schemes can be converted into tax free cash at the time the pension commences and the same applies to trivial commutation lump sums. So 25% will be free of tax and the remaining 75% will be taxable as normal income in the year in which it is paid.

If a trivial commutation lump sum payment is made in exchange for a pension already in payment, however, then all of that payment will be taxable as normal income in the year in which it is paid.

In all cases, there are rules about how much you can receive as a trivial commutation lump sum, and when you can receive it.

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What are the three rules of trivial commutation?

There are three rules that must be taken into account to see if trivial commutation applies:

  • the commutation must be made at any time on or after your 60th birthday;
  • the total capital value of the pension that you wish to cash in, plus all of the other pensions to which you are entitled, must be within the definition of ‘trivial’, which is currently not more than £30,000. See ‘can you explain the £30,000 limit?’ for how this is worked out;
  • all trivial commutations that you wish to make must be made within 12 months of the date on which you cash in the first of them. You do not need to cash in all of the pensions you have, but if you take a lump sum from a particular pension you must cash in the whole of that individual pension.

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Can you explain the £30,000 limit?

In order to decide whether you are within the £30,000 limit you must add the value of all your pension entitlements together. How this works will depend on whether you are already receiving an income from the pension or not.

For pensions not yet in payment

  • If you have a pension from a former employer which is based on your earnings in employment, known as a ‘defined benefit’ pension scheme, they, or the pension scheme administrators, will be able to provide you with a cash value for commuting your pension;
  • If you have a personal pension scheme which is based on your own contributions, known as a ‘defined contribution’ pension scheme, you may have a recent statement showing a capital value of your fund which will give you a guide. We recommend that you get a commutation figure from the pension provider.

For pensions already in payment

  • For the purposes of testing against the £30,000 limit, these are valued at 20 times the annual pension income, so a pension of £750 a year, for example, would be given a capital value of £15,000. If you received a tax free lump sum when the pension commenced, the amount of the lump sum is added to this capital value. See the example of Mel below.
  • It is important to remember that this valuation is for testing against the limit only and the actual amount the scheme will pay out may well be different.
  • Different valuation factors apply if you started receiving your pension before 6 April 2006 – these are normally valued at 25 times the annual pension income with no account taken of any previous lump sums.
    If a formal offer of commutation is obtained from a pension provider, you must obtain formal offers of commutation for all of the pensions you wish to commute within three months of the date of that first offer and the first of them must actually be cashed in within that three month period. See the example of Kim below.

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Are any additional payments allowed within the same tax rules?

In addition to the £30,000 limit for trivial commutation lump sum payments, you are allowed further cash payments in exchange for a pension. For example:

  • up to £10,000 from certain occupational and public service pension schemes, or where payments are made to rectify an error;
  • up to £10,000 from a personal pension plan, but you can only use this rule for a maximum of three such payments;
  • additional payments of up to £30,000 on the winding up of a pension scheme or to a beneficiary on death of the person entitled to the pension. These types of payment are not subject to the condition that they must be taken on or after your 60th birthday.

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Do I have to pay tax on trivial commutation lump sum payments?

The pension payer will initially deduct tax under Pay As You Earn (PAYE) from the lump sum at the time of making the payment to you. How much tax is taken will depend on your circumstances. Commonly the situation will be:

  1. If the trivial commutation lump sum comes from a pension scheme operated by your former employer – either their own scheme, or one operated for them by a specialist pension provider – the pension payer will normally deduct tax on the basis of the tax code that applied to your earnings immediately before retirement;
  2. In most other circumstances, the pension payer must deduct tax from the trivial commutation lump sum using a 'basic rate' tax code. This means that the pension payer must deduct tax from the lump sum at a flat rate of 20%.

In both cases the pension payer will operate the tax code on a non-cumulative basis – in other words, the tax code takes no account of any balance of unused tax allowances to which you may be entitled or the cumulative tax you have paid so far in the tax year. As a result, you could pay the wrong amount of tax on your lump sum. A basic rate code should produce broadly the right tax deduction in many cases, but you may still need to check your position carefully.

The pension payer must provide you with a form P45, as if you were leaving a job, showing the amount of trivial commutation and the amount of tax deducted. Our experience is that some pension providers are not aware of this obligation under the PAYE rules, so if your pension provider does not, or is unwilling to, provide you with a form P45, refer them to HM Revenue & Customs' (HMRC) guidance on their website, which will help remind them of what they are required to do.

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How do I claim a refund from HMRC?

You might pay the wrong amount of tax under PAYE when you receive a trivial commutation lump sum payment. Normally, HMRC will check your tax position based upon what they know about you at the end of each tax year and make any repayment due to you then. But you need to take care and check that any tax calculation and refund you receive from HMRC is correct.

If you are certain that you have paid too much tax, you can apply to have a tax refund before the end of the tax year. To do this, you should contact HMRC and ask them to send you a form P53 for completion. Or you can complete form P53 online on HMRC's website and then print out to send to HMRC.

Form P53 asks you to provide details of your income for the whole of the tax year in which you receive the trivial commutation lump sum. This will probably require you to provide estimates of your income for the rest of the year.

You should return the form to HMRC, together with parts 2 and 3 of the form P45 given to you when you received the trivial commutation lump sum.

If you do not complete a self assessment tax return, HMRC may ask you to complete a second form P53 after the end of the tax year to show actual figures and will make any necessary adjustments thereafter.

If you are not resident in the UK for tax purposes, for example if you have retired abroad, the above arrangements will not be applicable to you. Instead you should contact HMRC and ask to be sent a form R43. Alternatively you can download a form R43 from the HMRC website. You may be able to claim relief under a double taxation agreement. There is more information on how to do this on HMRC's website.

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Are there any other issues I need to consider?

Trivial commutation is full of rules which can trip you up. Some further issues which you should consider are covered in the next few paragraphs.

Interaction with state benefits

If you are in receipt of a means-tested state benefit – for example, housing benefit or council tax reduction – receipt of a trivial commutation lump sum will increase the level of capital you possess. There is more information on housing benefit on GOV.UK. You ca find more information on council tax reduction on GOV.UK. This might affect your ability to continue claiming that benefit.

Similarly, additional capital can reduce or extinguish your entitlement to pension credit – there is more information on GOV.UK. You should consider the position carefully before making the decision to take a trivial commutation payment and may need to take advice from a tax adviser. You can find a tax adviser on the Chartered Institute of Taxation website.

When to take a trivial commutation payment

It is possible to take a trivial commutation lump sum at any time from age 60 onwards. People who were born between 6 April 1938 and 5 April 1948 or before 6 April 1938 might be entitled to increased personal allowances. These increased allowances may absorb part of the tax otherwise payable, particularly if you were a non-taxpayer before you took the lump sum.

Delaying the decision to take a trivial commutation lump sum to a later tax year could produce a saving in taxes. For example, in the tax year in which you retire, you are likely to have higher taxable income and therefore potentially fall into a higher tax band, than you might in the tax year following retirement.

If you have a number of small pension policies it may be advantageous to cash them in over two tax years, but it is important to remember the 12-month rule .

Payments just outside the trivial commutation lump sum limits

There is no provision allowing payments that exceed the cash limits to be partly tax free; usually your pension provider will not make a payment which takes you over the limit. So be very careful, because if, as a result of receiving several trivial commutation payments, your total lump sum exceeds the £30,000 limit – and assuming none are additional ‘allowed’ payments – then all of the trivial commutation lump sum payments you receive may become subject to a penalty rate of taxation of 40%. This is particularly important to be aware of when commuting several pensions on separate occasions within the 12 month commutation period.

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Examples

Two examples may help to illustrate the principles:

Kim

Kim, age 62, has pensions not yet in payment under three registered pension schemes A, B and C, where the policies are worth £3,000, £2,500 and £4,000 respectively. Kim is not in receipt of any pension in payment.

The rules of all three of her pension schemes allow the commutation of trivial pensions.

Kim wants to commute her benefits as soon as possible in the 2015 calendar year and in order to do this her pension benefits must be valued within a three month period ending on the date the first trivial commutation lump sum is paid.

Kim’s pension rights are valued on 5 January 2015 at £9,500. To be a valid valuation, the first trivial commutation lump sum payment must be paid before 5 April 2015, within three months of the valuation.

Kim does not have to take her benefits as a trivial commutation lump sum from each scheme. She may choose to take her benefits under one or two of the schemes and not the other(s). But it must be an all-or-nothing decision in relation to each of the schemes, i.e. all the arrangements within an individual scheme – A, B or C – must be paid as a trivial commutation lump sum, or none of them.

Kim decides to draw all her benefits under scheme A (£3,000) and B (£2,500) as a trivial commutation lump sum. The benefits under scheme A are paid out as a trivial commutation lump sum on 2 February 2015.

The date this first payment is made will be the first day of the 12-month commutation period. Kim must draw any further trivial commutation lump from her remaining registered pension schemes before the end of the day on 1 February 2016.

Any payment from scheme B must therefore be paid by that date and must represent all her rights deriving from any number of policies under that scheme.

The benefits under scheme B are actually paid on 5 March 2015, within the commutation period, and Kim decides to leave the benefits held under scheme C.

She can change her mind and decide to fully commute these benefits up until midnight on 1 February 2016, but after this, the chance to commute the benefits held under scheme C is lost.

Mel

Mel, who is 64 in the tax year 2014/15, has pensions not yet in payment from schemes X, Y and Z with capital values of £5,000, £2,100 and £3,000 respectively (£10,000 in total) on 5 January 2013.

She also receives a pension of £1,000 from scheme W, which started in the 2011/12 tax year. At the time the scheme pension started Mel was also paid a tax free lump sum of £2,400.

Her pension rights from scheme W are valued at £22,400 (20 times £1,000 plus £2,400).

This means Mel’s total pension rights are worth £32,500 (£10,100 and £22,400) on 5 January 2014 and this is more than the commutation limit of £30,000. So none of Mel’s benefits under scheme Y or Z may be commuted and paid as a trivial commutation lump sum, nor can her pension in payment from Scheme W be commuted.

Mel might, however, be able to commute her pension under scheme X if it comes from a qualifying occupational, public sector or personal pension scheme under the additional £10,000 limit.

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Where can I find more help?

This can be a complex area of tax law and practice. For help on the tax aspects of trivial commutation, including filling in forms, if you are aged 60 or over and cannot afford to pay for tax advice, you can contact Tax Help for Older People for assistance. There are contact details on their website.

For benefits issues, you might be able to get help from an advice agency such as your local Citizens Advice Bureau. You can find contact details on their website.

The HMRC website has a section on trivial commutation.

For queries about the technical issues surrounding trivial commutation, for example, valuations of pension schemes, your first contact should be with your pension provider(s).

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