Small lump sums

Rather than using a small pension fund to provide an income, a scheme can pay the full fund as a small lump sum. The sum will be a one-off, taxable payment. It can be paid from crystallised or uncrystallised funds, subject to specific conditions being met.

There are different conditions to be met depending on the type of pension arrangement that the small lump sum is being paid from. There are three categories:

• payments from personal pensions and other contract-based pension schemes.
• payments from occupational or public service pension schemes.
• payments from larger occupational or public service pension schemes.

Small funds held in a personal pension, retirement annuity, section 32 buyout policy or trustee-proposed buyout policy can be commuted for a small lump sum if:

• the individual is at least age 55 (increasing to 57 in April 2028) or is taking benefits at an earlier age through ill health or because they have a protected pension age.
• the small lump sum payment does not exceed £10,000.
• the payment represents the full value of the member’s benefits held under the pension arrangement being commuted.
• the member has not previously received more than two small lump sum payments from other contract-based pension arrangements.

In effect, an individual can commute a maximum of £30,000 by taking a total of three small lump sum payments from three different pension arrangements. The payments can be made by different providers or by the same provider. Where they are made by the same provider, they can be made from arrangements held in different registered pension schemes or from ones held in the same registered pension scheme.

If a member has multiple arrangements under a scheme, it is possible to pay a small lump sum from up to three arrangements while leaving the other arrangements untouched.

Care needs to be taken when commuting a pension arrangement that is very close to the £10,000 limit as it is the value at the claim date that is relevant. For example, a member is told his fund is worth £9,950 and asks for this to be paid as a small pot; by the time the payment is processed the fund is worth £10,010 – it can’t be paid as a small pot. It might be possible to pay it as two small pots if the member had not previously taken more than one small pot payment. This would be achieved by ‘rejigging’ the arrangements held.

HMRC rules allow new arrangements to be created, for existing arrangements to be merged, or for funds to be transferred between arrangements in order to allow a small lump sum to be paid. A provider’s scheme rules, systems and processes will determine whether or not this is possible in practice.

Where an individual applies for fixed protection 2016 (or makes a successful late application for enhanced protection) between 16 March 2023 and 5 April 2025, the creation of new arrangements to allow funds to be paid as a small lump sum (for example, where funds above the small lump sum limit are held in one arrangement) could result in the fund protection being lost.

It will sometimes be the case that a member’s fund will only buy a very small pension but the conditions that would allow the fund to be paid as a 'trivial commutation lump sum' (which is a type of benefit in its own right) are not met. As an alternative, it may be possible to pay a small lump sum subject to the following being met:

• the member is at least age 55 (increasing to 57 in April 2028) or is taking benefits at an earlier age through ill-health or because they have a protected pension age.
• the member is neither a controlling director of a sponsoring employer of this or of any related scheme nor connected to such a controlling director.
• the ‘commutation value’ of the benefits to which the member is entitled under this and any related scheme is not more than £10,000 (this means that if someone is a member of two or more registered occupational or public sector pension schemes relating to the same employment, their total benefit value across all such schemes must be no more than £10,000).
• the payment extinguishes the member’s entitlement to benefits under the paying scheme.
• no recognised transfer has been made out of this or any related scheme in respect of the member during the three years preceding the date of the payment.

The commutation value is the amount of the lump sum paid; for final salary schemes, this is the actual value rather than the 20:1 valuation factor used for testing the lifetime allowance.

Subject to the above conditions, an individual could receive a small lump sum from every occupational pension scheme they have been a member of over their working life. There is effectively no limit on the number of small lumps sums an individual can receive from different occupational pension schemes.

These conditions also apply to public service pension schemes.

Larger occupational pension schemes can apply slightly less restrictive conditions when paying a small lump sum. The main difference is that a larger scheme can make the payment without reference to any benefits the member may have in another scheme for the same employment. Here are the conditions:

• there are at least 50 members in the scheme.
• the member has reached the age of 55 (increasing to 57 in April 2028) or is taking benefits at an earlier age through ill-health or because they have a protected pension age. 
• the member is neither a controlling director of a sponsoring employer of this or of any related scheme nor connected to such a controlling director.
• the payment does not exceed £10,000.
• the payment extinguishes the member’s entitlement to benefits under the paying scheme. If benefits are held in another scheme for the same employment, then those benefits don’t have to be paid as a small lump sum as well.
• no transfer payment from any other pension scheme (whether a registered pension scheme or not) was made to the scheme in relation to the member during the five years preceding the date of the payment, except where the transfer was an ‘acceptable transfer’ (as described below).
• no recognised transfer to a registered pension scheme or qualifying recognised overseas pension scheme was made out of this scheme in respect of the member during the three years preceding the date of the payment.
• the scheme is able to satisfy at least one of the following conditions:
  • the scheme was in existence on 1 July 2008, or
  • the payment is in respect of a defined benefit arrangement and the value of all the defined benefit arrangements under the scheme is more than half of the value of the total benefits under the scheme (that is, the scheme is mostly funded as a defined benefit scheme), or
  • there are at least 20 members whose individual benefit value is more than £10,000.

An acceptable transfer is a full or partial transfer from a defined benefit or cash balance arrangement to a defined benefit or cash balance arrangement under the scheme making the small lump sum payment, provided that:

• where the transfer is being made in connection with the winding up of the original pension scheme containing the defined benefit or cash balance arrangement, the receiving defined benefit or cash balance arrangement relates to the same employment, or
• the transfer is being made in connection with a ‘relevant business transfer’, or
• the transfer is being made as part of a ‘retirement-benefits activities compliance exercise’.

Each of these three points is covered in the HMRC Pensions Tax Manual at:

Subject to the above conditions, an individual could receive a small lump sum from every occupational pension scheme they have been a member of over their working life. There is effectively no limit on the number of small lumps sums an individual can receive from different occupational pension schemes.

These conditions also apply to public service pension schemes.

Scheme administrators may sometimes find themselves holding small amounts of money for members who have either taken their benefits or transferred their funds to another scheme. Typically, this could arise where, after benefits have been taken or transferred:

• a payment is made to the scheme which is not a contribution or a transfer in from any pension scheme, not just from a registered pension scheme or recognised overseas pension scheme, (for example, an unexpected late dividend payment),
• it is discovered there is an increase in the value of the member’s arrangement above which the scheme administrator expected (for example, where there has been a unit pricing issue or valuation error causing an undervaluation of a fund or transfer value), or
• the scheme administrator becomes aware that the member is entitled to a further benefit that it was not previously aware of or reasonably expected to be aware of (for example, where a redress payment is proposed to be made into a pension arrangement).

Any of these could result in additional funds being held for an individual in a scheme where they had previously taken benefits or transferred funds away. These additional amounts are referred to in HMRC guidance as ‘relevant accretions’ and can be paid to the member as a small lump sum if the following conditions apply and scheme rules allow:

• a transfer has been made from a registered pension scheme to another registered pension scheme or to a qualifying recognised overseas pension scheme, or
• a scheme has purchased a scheme pension or lifetime annuity from an insurance company. Where the purchase was made on or after 6 April 2006, the member must have had some or all of their lifetime allowance remaining at that time.
• the payment of the small lump sum extinguishes the member’s entitlement to benefits under the pension scheme (but where a scheme pension or lifetime annuity was purchased, the pension or annuity is ignored when determining whether the member’s entitlement to benefits under the scheme have been extinguished).
• the small lump sum does not exceed either £10,000 or the value of the relevant accretion and is paid within six months of the accretion payment being received or identified. 

Such a payment can be made to the member or in respect of the member, if the member has died.

The Financial Services Compensation Scheme (FSCS) is a statutory fund that aims to compensate policyholders if a financial services firm becomes unable, or likely to become unable, to pay claims against it. Generally, this would be where a firm has ceased trading and has insufficient assets to meet claims or becomes insolvent.

A compensation payment made under the FSCS can be paid as an authorised lump sum if:

• the payment does not exceed £10,000.
• it extinguishes the member’s entitlement to benefits under the registered pension scheme.

The payment doesn’t have to be made by the pension scheme itself. That is, it can be made directly by the FSCS and can be made either to the member or in respect of the member if the member has died.

If a small lump sum payment is paid from uncrystallised funds, 25% of the fund can be paid tax free with the balance subject to income tax in the tax year the payment is made.

For this purpose, ‘uncrystallised funds’ means funds where the member has not taken any benefits such as a flexi-access drawdown or an annuity. 

Where a small lump sum is paid from crystallised funds, all of the payment is subject to income tax in the tax year the payment is made. Typically, a provider will use the PAYE code already in operation.

When a small lump sum is paid to someone who is not the member (that is, where the member has died) the lump sum will be taxed on the recipient as income in the tax year in which the payment is made.

If there is no PAYE tax code already in operation, the provider will apply the basic rate tax code to the payment, which may mean that an individual ends up paying too much or too little tax, depending on their personal circumstances.

If too much tax is paid, the recipient can claim it back and there is guidance on how to do this on the government website. If more tax is due to be paid, the individual can account for this through self-assessment.

A small lump sum payment is not classed as someone flexibly accessing their benefits so doesn’t trigger the money purchase annual allowance.

The payment of a small lump sum is not a relevant benefit crystallisation event. As a result, there is no deduction from either the lump sum allowance or lump sum and death benefit allowance and an individual does not have to declare that they have enough of either allowance remaining to allow a small lump sum payment to be made.

HMRC’s guidance on the payment of small lump sums can be found at: