Will you be affected by the new Pension Simplification changes?
The countdown has begun to the biggest changes ever made to the Pensions Industry. Named A-Day by the Inland Revenue, 6th April 2006 is when the present pension rules will be scrapped and replaced by a single set covering every pension plan. Many people will benefit, being able to contribute more into their pensions and buy into a wider range of investments. But there could be losers too. Make the wrong decisions and you could be taxed at 55%. Do you need help and advise from us to make the most of A-Day? The answer is 'Yes' if you think that your situation is similar to any of the scenarios we will now cover. |
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PRE A-DAY
1 What to do before A-Day I'm in a company scheme. What should I do?
Most people in company pension schemes do not need to do anything: you can continue contributing as normal and your scheme trustees will take care of the changes.
But if you are close to retirement you may want to delay retiring until after A-Day to take advantage of more favourable benefits that will apply then.
Under the new regime you may be able to take more of your fund as tax-free cash. At the moment, company pension rules allow you to take a maximum of only 1.5 times your final salary as tax-free cash. From April 6, you will be able to take 25% of the value of your fund, which will mean many workers are better off.
If you have topped up your company scheme with additional voluntary contributions (AVCs) you will also be able to take 25% of the AVC fund as a tax-free sum. At present you must use the entire fund to provide an income. So if you haven't already done so, it may be worth making AVCs. Ask your company pension department for details.
The rules will also become more generous if your company scheme has opted out of the state second pension, which used to be known as SERPs.
From April 6, you will be able to take 25% of the contracted-out part of your fund as tax-free cash; at the moment it must all be used to produce an income.
It will no longer be necessary to stop work before taking benefits from a company scheme. You can even stay working for the same employer. Nor will you have to take all benefits at the same time.
However, there is no guarantee that the trustees of company pensions will adjust their scheme rules to reflect the new regime, so ask them about their plans.
2 There will be a tax on larger pensions. How do I avoid it?
The government is introducing a limit on the maximum value of your retirement fund. Called the lifetime allowance, it will be set at £1.5m in April 2006, rising to £1.8m by 2010. If you have a number of pension schemes, they will all count towards the limit.
You will be liable for a 55% tax charge on any amount above the lifetime allowance.
So, if your fund was worth £1.6m and the allowance was £1.5m, you would pay tax at 55% on the £100,000 excess, resulting in a charge of £55,000.
You should ask us to estimate what your fund is worth now, and its likely value in April and at retirement to see if you will breach the allowance.
With personal pensions and money-purchase company plans it is simple: compare the fund value with the lifetime cap.
With final-salary company pensions, however, the calculation is more complex. You will be deemed to have a value of 20 times your income in retirement. So a final-salary pension paying £75,000 a year will be regarded as being worth £1.5m.
If you have five years or more to go until retirement, you will have to make assumptions about the likely growth of your funds to work out if you will breach the allowance.
There are several ways to escape the tax, but you may need to act quickly to take full advantage. Savers will be able to register their funds on A-Day or up to three years after, to protect themselves against the charge.
If you plan to apply for protection, we recommend that you plough as much money as possible into your pension now. Savers with personal pensions can contribute between 17.5% and 40% of earnings up to £105,600. Members of occupational schemes can contribute up to 15%.
There will be two forms of protection - primary and enhanced.
Primary protection is available only if your fund is worth more than £1.5m on A-Day. It preserves any excess you have above the £1.5m allowance. So, if you register a £3m pot your personal allowance will be fixed at twice the lifetime limit.
Your personal entitlement will increase in proportion to any rise in the lifetime allowance. If the allowance jumped to £2m your personal entitlement at twice the lifetime limit would be £4m.
If your expected final-salary pension is £150,000 a year at A-Day - twice the limit - you can register for primary protection and stay at twice the limit.
You can continue paying into your pension, but if the fund grows faster than your personal limit you will have to pay the charge on the excess.
Enhanced protection is open to everyone, even people whose funds are below the £1.5m cap on A-Day. It shelters your entire pension fund from the tax charge, but you must stop all contributions before A-Day. Your investment and salary can grow without any fear that you will fall foul of the charge.
3 How do I protect my entitlement to more than 25% tax-free cash?
If you took out your pension before 1989, and in some cases later than that, you may still be able to take more than 25% as a tax-free lump sum.
You could lose this extra allowance if you transfer your pension in the future or leave your job.
To keep your full entitlement, we suggest you put your pension into a "section 32 contract" before A-Day.
4 I am a director. Should I set up an executive plan?
Under current rules business owners who have not used up their pension allowance in previous tax years can make extra contributions to an executive pension plan (EPP).
Suppose you started a company in 1986, but haven't made any contributions. By setting up an EPP now you can claim years of service right back to 1986. This entitles you to generous levels of tax-free cash, provided the contributions are made before A-Day.
Current rules allow the whole value of an EPP to be paid tax-free as long as the value of the fund is less than three-tenths of final pay, multiplied by the number of years worked.
So if you have 20 years of service and earn £100,000 in the year before retirement, you can take £75,000 tax-free.
5 I want to invest in commercial property. Can I do this now?
A self-invested personal pension (SIPP) can already invest in commercial property. If you want to invest, you may wish to complete your purchase before A-Day. After April 6, the borrowing rules for property become less generous. At present, a SIPP can borrow up to 75% of the value of a commercial property to fund a purchase. However, after A-Day you will be able to borrow only 50% of the value of your fund.
POST A-DAY
6 Take out a personal pension alongside your company scheme
The government will allow you to put a much broader range of assets in pension funds from 6th April 2006, but trustees of company schemes are thought unlikely to permit some of the more unusual investments, such as residential property, fine wine and vintage cars.
But if you are a member of a company scheme: you will be able to take out a self-invested personal pension (SIPP) alongside your company scheme and invest it where you like. But the maximum contribution and lifetime cap will apply to your company scheme plus your personal pension.
7 Make higher contributions
You will be able to pay in 100% of your earnings up to a maximum of £215,000, rising to £255,000 by April 2010. In the year before retirement, there is no limit at all.
At present, workers in company schemes can pay up to 15% of earnings. People with personal pensions can pay a fixed percentage of their earnings up to £105,600 depending on their age. Someone earning £100,000 in a company scheme could pay in up to £15,000 under current rules, compared with £100,000 from April 6.
8 Set up a family pension so your scheme doesn't die with you
The good news for those over 75 is that the new pension regime will enable you to avoid buying an annuity and pass pension assets on to your heirs. At present, if you have a money-purchase pension you must buy an annuity.
Under the new rules you will be able to avoid buying an annuity at 75 if you use an alternatively secured pension (Asp). To benefit from the rules your 75th birthday must be on or after April 6 next year.
With an Asp, your pension remains invested. You can take an income of up to 70% of the return you would have received from an annuity, but you do not need to draw an income if you do not need it.
When you die, any remaining funds can be used to pay a pension to a surviving spouse or dependant children under 23 in full-time education.
If there are no dependants you can create a special vehicle where you nominate family members or even friends as members of your scheme.
Unused pension assets may then pass to other scheme members on your death and can continue growing in a tax- advantaged pension fund.
When the beneficiaries reach 55, they can take 25% of the inherited pension fund as tax-free cash and use the rest to provide a retirement income.
It was hoped that, on death, you would be able to pass on any money or assets via an Asp free of all inheritance tax. But the Inland Revenue has indicated that it intends to review the inheritance-tax implications and is likely to impose a tax charge before the new rules come into effect.
The new regime is expected to be of most benefit to wealthier savers who at present go into income drawdown before 75 rather than buy an annuity.
9 Draw a higher income
The new regime will affect rules governing income drawdown schemes, where you keep your pension fund invested rather than buy an annuity. You will be able to take a bigger income - at present, there is a limit of 100% of the annuity that you could have purchased; from A-day, it will be 120%.
Drawdown will be open to all. Now it is only an option if you are a member of a personal pension or a special type of company scheme.
We recommend that you should have a fund of at least £100,000 before you consider drawdown.
10 Buy life insurance
You get tax relief on premiums if you buy life insurance using a pension. So a higher-rate taxpayer who is paying £100 a month into a policy needs to contribute only £60 of his or her own money. A basic-rate taxpayer needs to pay £78.
But the current rules are very restrictive. Only 10% of your pension contributions can be used to buy life cover. So if you make monthly pension contributions of £100 you can use only £10. On A-Day the cap on contributions will be scrapped.
IF YOU ARE INTERESTED IN DISCUSSING YOUR PENSION PLAN, AND THE PROPOSED PENSION SIMPLIFICATION CHANGES DUE TO TAKE EFFECT IN APRIL 2006. PLEASE SEND US AN EMAIL WITH YOUR CONTACT DETAILS AND WHAT IT IS YOU ARE INTERESTED IN LOOKING AT, AND WE WILL CONTACT YOU WITHIN 24 HOURS OF RECEIVING YOUR EMAIL.
