Ask Money: would my small pension pot ideas work?

Blick Rothenbergs Martin Reynard helps a reader with a question about retirement planning.

I recently came across the ‘small pot lump sums’ benefit whereby up to three separate small pots each worth up to £10,000 can be cashed in. Withdrawal doesn’t jeopardise ongoing pension contributions or lifetime allowance limits.

I have several friends who have NHS pensions but are seeking saving accounts for capital growth. Would it be possible for them to open up to three Sipps, pay in spare cash, benefit from the 20% tax rebate each year plus investment growth, and cash in the Sipp as the £10,000 limit is approached?

Additionally, I wonder if money can be transferred from uncrystallised large pots to a secondary small pension and then cashed in without triggering penalties and contribution limits?
Nigel Clarkson, by email

Martin Reynard at Blick Rothenberg replies: You are right that a pension arrangement worth less than £10,000 can be taken as a ‘small pot lump sum’. A maximum of three such small pots can be taken from ‘non-occupational’ (personal pension) plans. There is no restriction on the number of occupational or public service pension schemes that may be taken in this way.

A small pot lump sum is a retirement benefit, so it is not available before age 55. While 25% is tax-free, the remainder is taxed as income in the tax year of receipt. In that sense, taking a small pot lump sum is no different from drawing an ‘uncrystallised fund pension lump sum’ or a combination of tax-free cash and flexi-access drawdown. However, it does differ in that a small pot is not tested against the lifetime allowance and will not trigger the money purchase annual allowance (which might limit subsequent tax-relievable pension contributions to £4,000 a year).

Additional annual personal contributions of more than £3,600 gross paid into a Sipp will only receive tax relief if you have earnings in excess of this. If, as might be inferred, you have already retired and no longer work, you will be limited to further contributions of £3,600 a year with 20% tax relief.

You imply that the additional Sipp contributions will be funded from tax-free cash already received. You need to be careful, as there are strict rules around ‘recycling’ tax-free cash, which levy a tax charge of at least 40% on such contributions. The recycling rules are complicated. Whether a tax charge is triggered will depend on timing, amounts and the extent to which HMRC believes the exercise was planned solely to take advantage of pension tax breaks.

It is possible to partially transfer from one pension plan to another to create a small pot in the receiving arrangement. Alternatively, an existing segmented pension plan can be ‘reshaped’ by moving funds between segments to create up to three individual segments of the requisite £10,000 or less – it is the number of ‘arrangements’ that is limited. A single pension plan set up as, say, 100 segments, consists of 100 separate arrangements for the purposes of the small pot rules.

Be careful of allowing the proposed small pot to get too close to £10,000. While it may fall just short of £10,000 when a request for payment is made, it cannot be paid as a small pot if by the time payment is ready to be made it has grown to more than £10,000.

If you need help with a tax, pension or financial planning problem, please email: moneyobserver.ed@moneyobserver.com

Read more:
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