This guest post is by TaxHelp for Older People (TOP), a charity offering free tax advice to older people on incomes below £17,000 a year. The Helpline number is 0845 601 3321.
We all have different views about pensions. Some people have been in steady employment, have a company pension and are ready for retirement. Others are not so fortunate, have changed jobs frequently and have been in and out of pension schemes with little or no advice on how to manage them. Come retirement they then have a right old mess to sort out.
It will probably be the first time that they realise they have choices about what they can do and it will be unlikely that anyone has explained the rules very clearly. The paperwork received by most is littered with jargon, making it all very confusing. It is not surprising that many people get caught out and end up with large tax bills.
We find that just understanding the jargon helps.
Trivial Commutation – To take a pension as a cash lump sum rather than a regular payment.
Commute – As above.
Annuity – A pension (regular payment) purchased from money saved in your pension plan.
Pension Pot – The name given to the money you have accumulated in a pension plan.
25% tax free lump sum – The part of your pension plan that is tax free. Only 75% of the savings in a pension plan are taxable – the % can differ on some of the older schemes
Lifetime allowance – The maximum amount you can pay into a pension over your lifetime. It currently stands at £1,500,000.
1% Lifetime allowance – Known as the small pot limit. If all your pension pots added together total more than this figure you cannot commute any of your pensions. The limit is currently frozen at £18,000. There are a few exceptions to this rule; it is possible to commute certain company pensions with a pot size of £2,000 or less regardless of the £18,000 limit and from 06/04/2012 you can commute up to two personal pensions in your lifetime providing the pot size is £2,000 or less.
12 month rule – Once you have commuted your first pension you have 12 months in which to commute any others. After this time they become unauthorised payments and may attract a hefty tax charge of up to 55%.
As you approach your 60th birthday you will be approached by your pension plan provider/s. This can be your employer or an insurance company. You will be given choices:
- Do you want to take your pension now?
- Do you want to take a 25% tax-free payment and a lower yearly pension rather than a larger yearly pension?
- Do you want to commute your pension?
If you decide to commute your pension it is important that you think about all your pension pots and check that they do not exceed £18,000 in total. As an approximate guide to calculate the pot of an occupational pension, multiply the annual pension by 20. Once commuted, make sure any other pension plans you wish to commute are completed within the 12 month period.
In our experience the vast majority of people will overpay tax when they commute their pension and will need to complete a form P53 to claim it back. Contact HMRC on 0845 300 0627 and ask. You will receive one form immediately and another at the end of the tax year.