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Three reasons why you may want to keep three small pension pots

Paloma Kubiak
Written By:
Paloma Kubiak

The average worker has 10 jobs in their career which could mean 10 separate pension pots. While consolidating them may make things easier, there are some reasons to hold on to a few small pots.

Many people opt to bring all their separate pension pots into one account which helps them keep track of their retirement savings, and it could mean lower fees and more investment choice.

But there is a case for holding on to three small pension pots. Below we outline three reasons for you to consider if you have a personal or workplace defined contribution pension (excluding occupational pension schemes set under trust as there’s no limit on the number of pension pots you can have):

Small pension pot rules

Kate Smith, head of pensions at Aegon, says the small pots rule “is one of those little-known pension rules which can provide increased flexibility”.

She says: “It can be a good idea to keep a few small pension pots separately rather than consolidating them into one or more larger pension pots to benefit from this flexibility.”

Smith explains that a small pension pot is one with a value of £10,000 or less under contract-based arrangements, such as a personal pension or Self-Invested Personal Pension (SIPP), and includes individual and workplace schemes.

This valuation relates to the point at which it is accessed, so for Defined Contribution (DC) pensions, it is simply the value of the fund.

“It’s possible to take up to three pension pots from three separate arrangements. Each must be no more than £10,000 in value. If the value exceeds £10,000, even by a penny, it’s no longer counted as a small pot under the pension tax rules,” she says.

Three benefits of holding small pension pots

1) 25% tax-free lump sum 

As with other pensions, those aged 55 (57 from 2028) can access their retirement savings, with the first 25% lump sum being tax-free, while the remainder (75%) is taxed as income.

If you have three small pension pots, you can take 25% from each in different years as and when needed. But that also means you’ll have to take the remainder from each as income as HMRC rules state “the payment must extinguish the member’s rights under that scheme”, that is, cashing in the whole pot.

2) Contributions are not limited to the lower £4,000 allowance

One of the biggest advantages of holding small pensions is that accessing them doesn’t trigger the Money Purchase Annual Allowance (MPAA) which is set at £4,000.

Typically, the pension annual allowance is the amount of money you, your employer and any third party can pay into your pension pot every year while benefitting from tax relief. This stands at £40,000 a year or 100% of your earnings, if lower, for most people.

But for anyone who has flexibly accessed their DC retirement money by taking out more than your 25% tax-free cash (the remaining income element), this triggers the MPAA which limits future contributions by the worker, employer or anyone else to a tenth of that figure at just £4,000.

“Taking a small pension pot doesn’t trigger the MPAA of £4,000. This means you and your employer can still save up to a maximum of the £40,000 annual allowance into a pension and get tax relief on your personal contributions. This rule is useful to those who have accessed their small pension pots, perhaps by topping up their earned income or to provide an income while taking time out of work, as doing so doesn’t limit the future amount they can save into a pension,” Smith says.

3) You can go £30,000 above the pension lifetime allowance 

Further, Smith adds that small pension pots are also not tested against the lifetime allowance, currently £1,073,100.

“The lifetime allowance is the value of benefits that can be paid to an individual from registered pension schemes as a lump sum or income without triggering a tax charge. This means that if you have three small pension pots you can save an additional £30,000, without attracting a tax charge.

“This gives additional headroom especially as the standard lifetime allowance has been frozen until April 2026, so this rule is particularly useful to high earners or those who have saved close to the lifetime allowance,” Smith says.

She says a tip for DC members is to regularly check the value of their funds, by signing in online to see valuations.

However, she urges savers not to “over consolidate” into a small pension.

“Give yourself enough headroom for growth. Investment growth can work against you sometimes. If the value has exceeded £10,000, wait for the value to drop if you wish to take advantage of the tax benefits of the small pots rule,” she says.

But she says this strategy needs careful thought as people shouldn’t stop pension contributions purely for the sake of small pot rules, as this may turn out to be detrimental to the their overall retirement plans.

Related: Your five-point pension transfer checklist