If you have a small pension you may be able to cash it in without this affecting how much you can save into another pension and receive tax relief on.
However, the rules on cashing in small pensions aren’t straightforward and vary depending on the type of pension you have. It’s worth trying to get to grips with them though, as it could give you greater control over your retirement savings.
You need to think very carefully about whether cashing in a pension is the right option for you as taking a cash lump sum out – even if it’s a small one – could push you into a higher tax bracket, leaving you with a potentially hefty tax bill to pay.
Always make sure you know exactly what you’d be giving up if you were to turn your pension into a cash lump sum too. For example, defined benefit or final salary schemes provide a valuable guaranteed income in retirement. You might not realise quite how much you’re losing by going for the option of cash upfront – especially as most people underestimate how long they live for.
Here we explain the small pension pot rules if you have one or more small pensions you want to cash in.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
Cashing in your pension: the rules
Pension freedom rules introduced in 2015 mean that if you have a defined contribution pension, otherwise known as a money purchase pension, you can usually take your whole pension as cash if you want to from the age of 55 onwards (rising to 57 from 2028), regardless of how big your pension pot is.
However, there are some significant drawbacks to consider, not least that you could also land yourself with a big tax bill if you’re taking out a large lump sum, as only the first 25% of your pension is tax-free.You can find out more about tax and pension withdrawals in our guide How much tax will I pay when I withdraw my pension?
If you just take your 25% tax-free lump sum pension cash, you can still pay up to £60,000 this tax year into your pension and benefit from tax relief. This is known as your Annual Allowance. As soon as you take out more than this, the maximum you’ll be able to pay into your pension each year is £10,000 in the current 2024/25 tax year, and becomes known as the Money Purchase Annual Allowance. You can find out more about how the MPAA works in our article What is the Money Purchase Annual Allowance?
Small pension pots loophole
There is a loophole in the rules if you have small pensions. Provided you have no more than three small pots of £10,000 each from non-occupational pension schemes and an unlimited number from separate occupational pension schemes) then subject to the scheme rules, you may be able to take these as cash lump sums without triggering the MPAA.
Not all company schemes will offer you the option to cash in your whole small pension, so you might have to move your savings to an alternative provider if you want to do this.
Example
Janet has three stakeholder pension plans, worth less than £10,000 each. These plans are uncrystallised, which means she hasn’t started taking retirement benefits from them. (It is possible to use small pots from crystallised funds too, but there would be no tax free element to a small pots payment from these). Her pensions are valued at:
Pension 1: £8,300
Pension 2: £9,100
Pension 3: £7,600
Total: £25,000
Janet closes all her pensions under the small pots rules. This returns:
Gross total: £25,000
Tax-free 25% lump sum: £6,250
Balance taxed at marginal rate, (assuming total income does not exceed basic rate tax band = 20%) £18,750 – £3,750 = £15,000
Total extracted: £6,250 + £15,000 = £21,250
Once Janet has closed her small pensions, she can continue to save up to £60,000 each tax year into a new pension if she wants to, and will benefit from tax relief on her contributions.
Can I cash in a small defined benefit pension?
If you have a defined benefit or final salary pension worth less than £30,000 you can usually cash it in under what are known as ‘trivial commutation’ rules.
Bear in mind the £30,000 limit applies to ALL your pensions, so if you have several small pensions and they add up to more than £30,000 in total (ignoring the State Pension), you can’t turn them into a cash lump sum.
You don’t have to cash in all your pensions at the same time but you do have to do so within the same year. You can only take 25% of your pension tax-free, the remainder will be taxed at your marginal rate.
Your defined benefit pension scheme should send you a list of retirement options including taking ‘a trivial commutation lump sum’ as you approach retirement. This tells you how much you would get if you took this route.
If the value of your defined benefit pensions is higher than £30,000, you’ll only be able to cash in your savings if you transfer to a defined contribution pension. However, this is rarely a good idea, as you’ll be giving up a valuable guaranteed income in retirement. You must seek professional independent financial advice if you’re considering taking this route. Find out more in our guide Should I transfer my final salary pension?
What age can I cash in a small pension?
The earliest age you can cash in a pension is 55, increasing to 57 in 2028. Be very wary of anyone who tells you that you can access your retirement savings earlier than this, as it’s likely to be a scam.
You can find out more about pension scams and what to watch out for in our guide Don’t let scammers steal your retirement.
Where to go for more help
Although the lure of a lump sum from your pension might be tempting, it’s important to remember that taking money out of your retirement savings early on means you’ll have less to live on later on. Find out more about the pros and cons of dipping into your pension to boost your income in our guide Should I use my pension to boost my income?
It’s worth doing plenty of research before you cash in a small pension. If you’re aged 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service. However, if you want personal recommendations or advice about your specific circumstances, or if you have a defined benefit or final salary pension, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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