Small pots and defined benefit trivial commutation Q&A

Q. What is a small pot (technically known as a small lump sum) payment and do all pension schemes offer this option?

A. Finance Act 2004, ie the legislation which applies to registered pension schemes, authorises specific types of lump sum payments that may be paid to members, one of which is a small lump sum. This payment type means that where a client has pension benefits that satisfy specific criteria, it may be possible to commute these for payment of a one-off (small) lump sum. There are different criteria depending on the type of scheme/ arrangement which holds the pension benefits. These conditions are covered in our article – small pots and defined benefit trivial commutations.

Where a scheme offers this option, each payment cannot exceed £10,000 at the time it is paid. 

Small pots from non-occupational pensions are limited to three in the client’s lifetime and each payment must extinguish pension rights held in the arrangement.

There is no limit on the number of small pots from occupational pension schemes providing each payment extinguishes benefits held in the paying scheme.

It is not mandatory that any scheme offers this option. You should check the scheme rules.

Q. Is there any benefit to receiving a small pot (lump sum) payment instead of an uncrystallised funds pension lump sum (UFPLS)?

A. Small pots do not use, or require the customer to have any available lump sum, or lump sum death benefit allowance available. Where it’s paid from uncrystallised funds, 25% of the amount will be tax free. Small pots can also be paid from crystallised pension funds but will be taxable.

An UFPLS can only ever be paid from uncrystallised funds. The tax free amount will be between 0%-25% of the lump sum paid and will normally depend on how much lump sum and lump sum death benefit allowance is available. In some cases the rules around when an UFPLS can be taken and how they are taxed are more complicated. More information about UFPLS can be found here.

Small pots do not trigger the money purchase annual allowance (MPAA). An UFPLS payment of any amount does trigger the MPAA.

Assuming there are sufficient allowances to allow an UFPLS to be paid 25% tax free, although the initial tax may be different from an equivalent sized small pot (usually small pots are taxed at basic rate and UFPLS at emergency rate), both types of payment are ultimately treated in the same way. Any over or underpaid tax would need sorted out with HMRC directly. 

Q. My client has a small SIPP worth £24,000. Can he take this as three small pots?

A. This may be possible depending on the provider who holds the arrangement. They may be able to separate this into multiple arrangements. For those who held enhanced or any of the fixed protections on the 15^th March 2023, setting up a new arrangement for this purpose will no longer lose their protection. For those who applied after that date, setting up a new arrangement would result in the loss of their protection. 

This answer relates to non-occupational pension schemes only, as one of the conditions for a small lump sum payment is that each payment of up to £10,000 must extinguish the member’s rights under the arrangement making the payment. 

This is fundamentally different from the condition for a small pot payment from an occupational pension scheme which must extinguish the member’s rights to benefits under the paying scheme.

See the Pensions Tax Manual for more details.

Q. What benefits are taken in to account for the triviality option post 6 April 2015?

A. Pre-crystallisation, triviality is now only an option for the payment of defined benefit (DB) scheme benefits. Although it is only DB benefits that can be paid under this option, ALL pension benefits from any registered pension scheme (including those already crystallised and those which remain uncrystallised) are taken into account when valuing the benefits to test they do not exceed the commutation limit of £30,000. 

Further details are in the HM Revenue & Customs Pensions Tax Manual.

Q. My client’s defined benefit (DB) pension scheme sent her a list of retirement options including ‘a trivial commutation lump sum’. They offered a lump sum payment, which would be subject to tax, of £22,500. When we told them about two small personal pensions also held, with funds of £5,000 and £8,000 respectively, they have withdrawn the option of triviality. Why is this?

A. As the value of pensions from all sources total £35,500, this exceeds the £30,000 commutation limit. This means your client is not eligible for triviality from her DB scheme benefits. The DB scheme would not have known this until you gave them values for your client’s other pension funds.

The HMRC rules for paying a trivial commutation lump sum state, as one of the conditions, that all of a member’s crystallised and uncrystallised rights under any type of pension arrangement are taken in to account when testing the £30,000 commutation limit. So, although since April 2015 (on retirement) it is only DB pensions that can be paid out under the triviality rules, the value for any money purchase pensions must still be included to work out if the client is eligible.

Q. Following on from the previous question, is there a practical solution that would allow the DB scheme benefits to be settled under triviality?

A. Yes there is. If the personal pension scheme worth £8,000 offers the small pot option you could take that payment first. This does not use up any allowances and reduces the value of funds to be tested against the commutation limit. This takes pensions from all sources below £30,000 (£22,500 + £5,000 = £27,500) making your client eligible for triviality from her DB scheme benefits.

Q. What pensions are tested against the £30,000 commutation limit for a trivial commutation lump sum death benefit?

A. This is fundamentally different from the rules for a trivial commutation lump sum on retirement. Where the triviality payment is offered in respect of a death benefit, £30,000 is the maximum amount per scheme, rather than the maximum across all schemes.