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Small pot pension rules: what are they and how do they work?

Pension Pot
Pension Pot

While it used to be common to work for only one or two companies for your entire career, workers today are likely to have moved jobs several times throughout their working lives – which can have a big impact on your pension savings.

As a result of switching employers, you could end up with a large number of workplace pension pots – the average by the time you reach retirement is 11 – making it very complicated to keep track and access them when you need to.

If you are in certain types of occupational pension schemes, then you could also face a complicated job working out how to be tax-efficient when it comes to withdrawing your money.

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Such pots are seen as a drag on the system and lead to unnecessary administrative costs. There is also a concern that you could lose track of your pension pots and forget about one.

This guide will explain the rules around small pensions and when you can and cannot withdraw them.

What qualifies as a small pot pension?

Any pot worth less than £10,000 is classified as a “small pot pension”.

Different rules apply to pots of this size, and the money held in them can often be withdrawn in a more tax-efficient way.

The creation of auto-enrolment has had the positive effect of causing millions of people to save for retirement for the first time, but the unfortunate downside is that many people have accrued several small pots.

There could be as many as 27 million of them by 2035, an increase from eight million today.

You can check to see if you have a forgotten small pot pension by using the Pension Tracing Service, which is provided by the Government.

You will need your National Insurance number and the names and addresses of previous employers.

What are the benefits of a small pot pension?

A small pot pension does have some benefits when it comes to making withdrawals. These include:

  • They can be withdrawn without affecting your pension annual allowance (other types of withdrawals classified as pensions flexibility payments will restrict you to only being able to pay in up to the £10,000 money purchase annual allowance for future contributions, but withdrawals being treated as “small pots” still allow you to pay in up to £60,000)

  • You can take them as a lump sum

  • You can easily transfer them to another pension provider

Despite the benefits, it’s not necessarily worth keeping your savings in separate small pots.

Keep reading about what your options are if you’re not sure what to do with your small pot pensions.

What can I do with my small pot pensions?

There are several options available to those with one or several small pot pensions.

You could combine a smaller pot with another pension you are currently paying into, which could make it easier to keep track of how much you have saved, and also manage what your retirement savings are invested in.

There could also be benefits in terms of reduced fees and charges.

Before doing this, you should check if you would be giving up any benefits associated with the scheme, as these may outweigh the benefits of consolidating your pots.

You could also withdraw your small pot as a lump sum – and there may be tax advantages to doing so.

You can do this if you are aged 55 or over, although this will increase to 57 in 2028.

You can withdraw up to three pension pots worth less than £10,000 each from different personal pensions, or an unlimited number if they’re different workplace pensions.

A quarter of the withdrawal would be tax-free, while the remaining portion would be taxable.

You should also remember that the lump sum would be classed as income and so you could end up with a bigger tax bill if your withdrawal pushes you into a higher tax bracket.

How to claim your small pot pension payments

If you want to transfer your pension to a new provider, perhaps one used by your new or current employer, the first thing to do is to check with your current provider that you would not be giving up any valuable benefits by leaving its scheme.

If you are happy to proceed then the process is fairly easy. You will need to get your “transfer value” from your current provider, which will also include any exit charges that might apply.

Give this form to your new provider and it will process the transfer for you.

You have 30 days to change your mind, but be aware that changes in the value of investments could mean you get back less than you withdrew.

If you are aged 55 or over and you want to take the pot as a lump sum, then you will need to get in touch with the provider and they will tell you the process.

How should you use your small pot pension payments?

How you use your small pot pension payments is your choice.

You could combine the pot with your other pension pots to give you greater control over how you manage your retirement savings.

Or you could withdraw it to help fund your retirement.

You could even use the funds for a major project to help you enjoy your twilight years – perhaps home improvements, or a holiday you’ve always wanted to take.

Make sure you definitely have enough to fund your retirement if you choose to do this, however.

What are the tax implications?

There are no tax implications if you are simply moving your pot from one provider to another. There may be an exit fee to pay however, so this is something you should be aware of.

If you take your pot as a lump sum, then there are tax implications.

While 25pc of your pot will be tax-free, the remainder will be treated as income and taxed at your marginal rate.

For example, if you are a basic-rate taxpayer and your pension pot is worth £10,000, then £7,500 would be added to your income and taxed at 20pc.

If you have other sources of income, and aren’t far off the next tax bracket, be aware that taking your lump sum could push you up an income bracket leading to a higher tax bill.

It could be worth splitting your withdrawal across two tax years if this is a possibility. Because of the way this tax is calculated, you could end up paying more than you need to.

You might be able to claim back a tax refund. You can claim this back from HM Revenue & Customs (HMRC) by using form P53 or P53Z, depending on your circumstances.

You’ll need to tell HMRC about any other income you’re expecting to get during the tax year, and figures from your pension P45. More information is available here.

What should I consider before I access my pension?

Before accessing your small pot pension, make sure you understand the taxation rules that apply and be aware of how to claim a refund if you pay too much tax.

If you are transferring a pension to another provider, then make sure you are not giving up any valuable benefits offered by your own scheme – these could make it more advantageous to leave your money where it is.