Over-60s able to cash in smaller pension pots

[CliveH]

HMRC allow a thing called Trivial Commutation whereby if your pension pots add up to less that £18,000 you can take it all as cash less tax rather than have to purchase an annuity. You can have 25% tax free and pay your rate of income tax on the remainder.

 

This “allowance” is being extended so that people with several pension Pots that add up to more than £18,000 but where some are small pots less than £2000 will after April 6th this year be able to take a max of two small pots (less than £2000 each so £4000 in total) as cash.

 

So if Fred has three pensions – one of £100,000, one of £1000 and another of £2000 under the old rules he would not be elligible for Trivial Commutation as the total is £103K.

 

But from April this year he can take an annuity or Drawdown from the £100,000 but the two small pots of £3000 in total he will be able to take as cash (less tax) without having to buy an annuity. Only two “pots” will be allowed this concession as HMRC realised that IFA’s would split pots to circumvent the annuity rules if given a free hand (and this was exactly my thought !! when I saw the rule change before I saw the “two pot” restriction)

 

This a is a welcome and sensible rule change. More details in this article from the Guardian:-

 

 

“Rule changes from April 2012 mean workers with a series of small pensions will be able to cash in two pots as a lump sum

 

A £1,000 pension pot would provide an income of only about £5 a month. From April you will be able to take it in cash. Photograph: Graham Turner for the Guardian

 

Do you have less than £2,000 sitting in a pension at a company where you worked for just a couple of months or years? Rule changes announced by HMRC will, for the first time, allow workers to take the money as a one-off cash payment when they reach age 60.

 

HMRC says the rule change, which comes into effect from April 2012, will initially benefit just 25,000 people, but experts say the number could rise into the millions thanks to the explosion in company personal pension selling in the 1990s.

 

A pot of £1,000, for example, would currently provide a 65-year-old man with an income of only £5 a month.

 

HMRC has always allowed what is known in the pension world as "trivial commutation" of small pots of money into cash. As long as the total sum saved into a pension is below £18,000, the individual is allowed to take it all as cash on retirement.

 

But the rules have trapped people who built up a reasonable pension at one employer, but had small sums scattered around in other pots when, for example, they were younger and job-hopping. Until now, for pension purposes all the pots were added together and if they exceeded £18,000, the money could not be taken as cash. But from April 2012, any individual pot of money below £2,000 can be taken as cash, even if the person has a substantial pension from employment elsewhere.

 

HMRC will allow 25% of the money to be taken free of tax, with the rest taxed at the individual's marginal rate of income.

 

Individuals will only be allowed to access a maximum of two "trivial" pension pots of up to £2,000 each. The government is concerned that financial advisers would split pension pots into hundreds of mini-pots to circumvent the annuity rules.

 

This is a welcome development, which will mean investors with very small pension pots will no longer have to buy an annuity and will instead be able to take their savings as a lump sum. It will also take some pressure off annuity providers, for whom these very small pots are unprofitable."

 

[Dave225]

I agree Clive but one should do the numbers before going down this route. As soon as you mention 'cash' to many people their eyes light up and spend the lot on whatever, then it is lost forever. Also what would you do with the £2000 if you do not blow it on a holiday? Taking the tax free sum and assuming 20% tax gives £1450 to play with and a rate of 3% which is about as good as you can get will give an annual interest of £43.50 if my maths is right. I accept annuities are poor but many are still offering about 4.5% so the £2000 will generate £90 per annum for life. Certainly not brilliant but maybe better for the long term view.

 

I accept the cash option is fine if you indeed have a larger pot to provide income, but I suspect many will not.

 

However, one other part of this legislation which is useful is the fact that protected rights benefits will no longer be separated so you can combine them with a personal scheme and maybe get a better rate for the total.

[CliveH]

On a practical note Dave if you have a pension pot of £2000, then via an annuity with no Tax Free Cash (why on earth would anyone NOT take the Tax Free cash????), then as you say an annuity would produce 90 a year. Or £7.50 a month, which after tax would net down to £6 a month or £72 a year net.

 

First consideration is who on earth as an annuity provider would want that business? Even if it was taken annually in arrears - the cost of setting up an annuity is the same for £2000 as it is for £20,000 or £200,000. So the number of providers that will take this small sum on is minuscule and because of the fixed rate charges applied to annuities, the "hit" taken as a set up charge is staggering.

 

Plus the fact that if you set up the annuity and then walk under that proverbial bus then all you do is leave your fund to all those lucky souls that live a long time. Do you want to leave your money to people you do not know, never met and never likely to?

 

The alternative is as you say, via the new rules, take the Tax Free Cash of £500, then the rest after a 20% tax = £1200 - so that is a total of £1700 - not £1450 as you suggest.

 

If this was placed in an ISA at 3% the annual interest would be £51 - Not as good as current annuity rates I grant you - but todays low interest rates will not last forever, and only a few years ago, it was possible to get more like 5% via an ISA and when those time return, as they surely will, then 5% on a sum of £1700 will generate £85 a year tax free.

 

PLUS! - and it is a significant plus - this £1700 is yours - in an account with your name on it. If you die it goes to your spouse or your children. If you purchase an annuity the annuity income dies when the last named annuitant dies.

 

Yes an annuity can be written in joint names so it can continue being paid to your spouse, but if your wife is younger than you and as women live longer than we men anyway, including a female spouse as joint annuitant is very expensive and would reduce the annuity rate considerably.

 

I agree with what you say re the legislation on PR's - another welcome relaxation of the rules.

 

Shame they "balanced" the welcome changes with the unwelcome increase in the Recovery tax charge on Drawdown plans from 35% to 55% >:-(

 

[Dave225]

Clive,

 

I am not a fanatic of annuities by any means but.....I still am of the belief that people are greedy and ofetn unwise. If anyone does have the £1700 in an account sooner or later it will be 'dibbed' and then dibbed again. Unfortunately, it is usually those with lots of money who are able to stash sums away and forget about them. Yes, you can leave it to the kids but why? You can also get a guarantee with an annuity of up to 10 years so even if you do get hit by the proverbial bus then there will still be some payout. ISA rates are going to have to get back to over 5% before that route makes sense and I do not see that happening for at least 2 years. I cannot comment on set up costs as these are never revealed to the customer, but from quotes I have received over time the difference between very small sums and just small sums seems to be insignificant and the payout percentages still come close to what rates are being offered for larger sums. Also all quotes I have ever had have been on a no commision basis.

 

I have worked these sorts of sums many times trying to figgure out the best route and what I came up with was to spread your money in as many different routes as you can. Some cash, some investments, some pension and never believe what anyone tells you is the best option. They are usually only interested in a personal payback.

 

However I do accept that as only 2 pots of £2000 will be eligible for this it is probable most people will take the cash and run. I suspect holidays will be the main benficiary and maybe why not. Currently saving is a mugs game, but that may change.

[CliveH]

Build in a 10 year guarantee and a spouse’s pension to protect the capital and you will virtualy halve the annuity rate - you would be down to circa 3% annuity rate probably lower for small "pots" - the table from HL via the FT shows that the rate is 3.6% for a 50% spouse’s pension and 3% escalation - options that are "cheaper" than a 10 year guarantee.

 

http://www.ft.com/personal-finance/annuity-table

 

So if we assume a c.3% annuity rate that means it will take 33.3 years to break even - i.e. get your money back.

 

For a 65 year old male this means living until you are 98.

 

How many of us can expect to do that?

 

As for frittering it away - what you say is sensible on the surface - but delve deeper and if the annuity rates are so low and the fund so small, such that the returns amount to a few quid a month - less than £100 a year and it takes decades to get all of your "pot" repaid to you, surely you may as well be giving your £2000 away? Because that is effectibvely what you do by the purchase of an annuity.

 

I like the fact that the rules are being relaxed sensibly to allow some of these small pots to be taken as cash. As you say - it is only for two "pots" and they have to be under £2K. so we are not talking large sums here - but from a professional viewpoint - these small pots at retirement are a nightmare.

 

Providers have a minimum Transfer value of usually £50K so we cannot amalgamate small pots into one large "pot". So individual annuities are usually the route we have to go. And the rate given to small pots is far less per £1000 to large ones.

 

I think we have to remember that it is the individuals money and they should - in my view - be able to do what they want with their own accrued funds.

 

As for saving being a mugs game - it is if you rely on deposit accounts.

 

If you look at ISA's for Fixed Interest, with a smattering of Property funds and perhaps even Emerging markets - then the returns are very good indeed - and for such small sums - in my view - better to consider this than throw the money away on an annuity where it will take decades to have it slowly drip fed back to you with no benefit to your family.

 

Annuities have been described as being for people who dislike their families more than strangers.

 

But each to his own. (lol)

 

[josie gibblebucket]

Does the trivial commutation rule apply to final salary pots too? I have a couple of very small ones to come, but have no idea what they are actually worth as a lump sum. Is there a sum I can do to work it out?

 

On a different note, the savings i had put by for my old age were spent on solar panels, I decided I was likely to get a better return from them than ever I'd have got from an annuity - 25 years index linked and tax free income. If I get 8 -10% I'll be well chuffed!! :-D :-D

[CliveH]

Well done on the Solar Panels - the subsidy is halved now so your timing was good. Clients of mine who did this have gained £56 rather than having to pay anything for their electricity! And that includes their using an electric emersion heater now rather than their gas boiler to heat their water.

 

This is a considerable saving and "return" on their "investment" which at todays low interest rates I as their IFA would struggle to match via any traditional investment.

 

As for the Trivial Commutation (TCom) - yes it applies to all pension schemes - we have to write to your pension schemes and ask for the CETV (Cash Equivalent Transfer Value) - all schemes know about this and it is a standard calculation that we have to calculate to satisfy HMRC's requirement for each individual to supply them with the percentage of LTA (Life Time Allowance) used.

 

Just note that the actual figure needs to be calculated a few months prior to retirement to satisfy HMRC, - BUT - you need to be aware of the rules long before that in order to make the correct decision.

 

For example - all trustees of occupational schemes can refuse a transfer to another scheme within the last twelve months up to the schemes NRA (Normal Retirement Age) - so we recommend obtaining CETV's as you approach retirement to ensure that your options remain open to you.

 

If TCom is attractive to you and your fund could go above the £18,000 barrier before retirement date then it would be prudent to ensure that the fund does not grow beyond the £18,000.

 

The figs are:-

 

Fund of £17999 will allow £4499.75 tax free cash and the remainder to be taken as cash less tax (assume £20%) which is £10,799.40 net - so that is a cash lump sum of £15,299.15 - yours to do what you want with.

 

But a fund of £18,001 will allow £4500.25 Tax Free cash and the remaining £13,500.75 has to purchase an annuity (could theoretically go into Drawdown but the fixed costs are high and most good providers will not allow Drawdown on funds less than £100K because of this) which at todays annuity rates would give you about £675 a year gross or £540 pa after tax.

 

Which as I have said in another thread, means that you HAVE to survive 25 years in retirement just to break even.

 

So my advice re TCom is to find out what your pension funds are worth and if they are nudging the £18,000 TCom limit, possibly consider placing them in cash to limit the growth if TCom is attractive to you.

 

Anyone that wants specific advice can always PM me - we are happy to do a bit of Pro bono work to assess peoples pension funds (it gives us brownie points with the FSA!! (lol) )

 

We can give you the email address for our admin department who will contact your providers on your behalf.

 

[josie gibblebucket]

CliveH - 2012-01-17 8:43

 

If TCom is attractive to you and your fund could go above the £18,000 barrier before retirement date then it would be prudent to ensure that the fund does not grow beyond the £18,000.

 

So my advice re TCom is to find out what your pension funds are worth and if they are nudging the £18,000 TCom limit, possibly consider placing them in cash to limit the growth if TCom is attractive to you.

 

Thanks for the helpful info - unfortunately the 2 final salary pots I've got are with the Civil Service and Boots - neither of which give me any choice as to where they are invested, well the civil service isn't even invested is it? Its just a promise really. Do you think the amounts ie £18000 and £2000 or less, are likely to be increased over the next few years to take account of the fall in real values? I have a few years to go yet and think I may go over these amounts even if my pots are only increased in line with CPI?

[CliveH]

josie gibblebucket - 2012-01-17 11:02 AM

 

CliveH - 2012-01-17 8:43

 

If TCom is attractive to you and your fund could go above the £18,000 barrier before retirement date then it would be prudent to ensure that the fund does not grow beyond the £18,000.

 

So my advice re TCom is to find out what your pension funds are worth and if they are nudging the £18,000 TCom limit, possibly consider placing them in cash to limit the growth if TCom is attractive to you.

 

Thanks for the helpful info - unfortunately the 2 final salary pots I've got are with the Civil Service and Boots - neither of which give me any choice as to where they are invested, well the civil service isn't even invested is it? Its just a promise really. Do you think the amounts ie £18000 and £2000 or less, are likely to be increased over the next few years to take account of the fall in real values? I have a few years to go yet and think I may go over these amounts even if my pots are only increased in line with CPI?

 

Hi Josie

 

Sorry but you are confused about how these things work (not surprising because the rules have evolved over years and are constantly being played with by the authorities.

 

All schemes have a CETV, regardless of what type of scheme they are. With a Money Purchase scheme it is easy in that the CETV is simply the fund value at retirement. But with a Final Salary scheme the promise to pay a pension of a %’age of Final Salary is calculated by the actuaries but for simplicity it is akin to 20 times the pension to be paid plus the tax free cash.

 

It is twenty because the annuity rates today are circa 5% - so 100% divided by 5% = 20 so if you had a Money Purchase Pension pot after Tax Free Cash of £100,000 then a 5% annuity would give £5000 a year.

 

So similarly, a Final Salary “promise” of £5000 a year has a CETV of £5000 X 20 = £100,000.

 

Where it gets more interesting is where in the Civil Service scheme you have full indexation (was RPI – now CPI) and those annuities if bought on the open market are much much more expensive and so the actual assumed annuity rate might be down to 3% which means that the actuaries within the scheme would calculate the CETV as being closer to 33 times the pension in payment. Thus a £5000 a year pension via the Civil Service scheme has a CETV of closer to £166,000.

 

What your scheme has to provide the HMRC is the CETV. Final Salary Schemes must provide this but often they fob of scheme members saying that they do not need to do the calculation until nearer retirement and in a lot of cases that is too late and certain “windows or opportunity” exist for short periods only.

 

For example – Government schemes in particular will not provide any more information to any individual or their agent if information has been provided in the previous 12 months. On many an occasion I have sought confirmation of NHSPS details on behalf of a client only to be told that because they themselves sought info a while back we will have to wait months (until 12 months have past from their initial enquiry) before we can get ALL the information necessary to make an objective decision.

 

When we approach these scheme we make it clear that we are carrying out a full review and that under the same authority we may seek clarification of the facts. This gets round their silly little game playing.

 

So as I say – to find out what your cash value is – I suggest you get an authorised individual to do it on your behalf. Happy to do that for Forum Members if you wish as we are always quiet at the start of the year.

 

Plus we have just taken on a new trainee and it would be good experience for him – tho we would oversee it all and provide you with the results in full confidence. - ie in writting - NOT via this Forum

:-D

[josie gibblebucket]

Sounds great _ I'll pm you