The new pensions regime Print E-mail
Written by Bijal Shah   
A pension is intended to provide you with a secure income for life once you have retired. There are currently four sources of pensions income:
  1. The basic state pension is based on your National Insurance contributions record. It is a safety net rather than a retirement plan. From 6 April 2006 the full basic state pension was £84.25 per week for single pensioners and £134.75 for couples.
  2. State second pension is additional to the basic state pension. The amount is based on your record of National Insurance contributions and your level of earnings as an employee.
  3. An occupational pension is arranged through an employer’s pension scheme. Often the employer will make a contribution.
  4. A personal pension scheme is open to nearly everyone and is especially useful if you are self-employed or if your employer does not run a company scheme.
To encourage you to save for your retirement in a private pension, the Government gives tax relief on contributions to a pension scheme at your highest rate of tax. For every 78p a basic rate taxpayer contributes to a pension, the Government will add 22p. A higher rate taxpayer has every 60p boosted by 40p. The pension fund then grows free of income tax and capital gains tax. When you draw your pension at retirement age, you can take 25 per cent of the fund as a tax-free lump sum. The remaining 75 per cent is used to generate a retirement income on which you are taxed.

Many people are higher-rate taxpayers during their working lives and basic rate taxpayers in retirement, which makes pensions work to your advantage.

New rules


From 6 April 2006 a simpler set of rules replaced the previous ones. The new rules are retrospective, applying to all the pension sums you have built up, as well as those you will build up in the future. The main features and benefits are:

Generous contributions limit
Before 6 April 2006 there were limits on the contributions that could be paid to your plan each tax year depending on your age and earnings. Now you will receive tax relief on your contributions to all registered pension schemes up to 100 per cent of your earnings a year, or £2,808 a year if you have no earnings (which equals £3,600 once tax relief has been added). However, if contributions from all sources are greater than the annual allowance (£215,000 for 2006–07) you will have to pay a 40 per cent tax charge.

There will still be no limit on the size of the pension fund you can build up, but the combined value of all your pension funds at retirement will be assessed against a new lifetime allowance. The lifetime allowance for 2006–07 is £1.5 million and this is likely to increase each subsequent tax year. Funds in excess of this will be subject to a tax charge and the amount will depend on whether the excess funds are used to provide a lump sum or pension.

You can safeguard your pension fund assets from this tax charge by applying for one of two types of protection – primary and enhanced protection. The superior level of enhanced protection will require you to stop making further contributions into your pension. You can register for primary protection by 5 April 2009 provided your pension funds were worth more than £1.5 million on 5 April 2006. You can continue to pay further contributions and your funds will be allowed to grow broadly in line with retail prices without you having to pay the extra tax charge.

Flexibility
As long as you don’t break the annual and lifetime limits you can contribute simultaneously to as many different pension schemes as you like. Higher earners in particular will be able to boost their retirement planning with contributions to self-invested personal pensions (SIPPS), which allow greater investment control and choice.

For example, if you are a member of an occupational scheme with fairly limited investment choice, you could make enough contributions to the scheme to get the full employer contribution and then diversify your retirement pot into another pension on top of this. If your employer only offers index-tracking investment options, you can invest in actively managed funds through a personal plan.

Small pension savings
Any total pension pot that is worth £15,000 or less is classified as a ‘trivial pension’ under the new rules and can be taken as a cash lump sum on retirement. The £15,000 is 1 per cent of the lifetime limit – the trivial pension amount will rise each year in line with rises in the lifetime limit.

Death benefits
Improved death benefits are an important feature of the new regime. There is now no link between salary and death benefit pension in pension schemes. Personal pension investors will be able to buy life insurance through their pension scheme, called “personal term assurance” and get tax relief on the product at their higher rate.

In occupational pension schemes, lump sum death benefits will no longer be restricted to a maximum of four times salary and could be as high as the lifetime allowance.

Tax-free cash
From 6 April 2006, your maximum tax-free cash entitlement is calculated as an amount equivalent to 25 per cent of the value of your pension fund. If you have a personal pension or stakeholder pension, then the chances are this is no different from your current tax-free cash entitlement.

Options at retirement
One of the key attractions of the changes is the removal of the requirement to buy an annuity at age 75. Instead, you will be able to draw your retirement income directly from your pension fund and pass what remains of it on to your family when you die. But some pensioners might be better off taking the traditional annuity route, particularly as there are some welcome innovations in this area.

The remaining pension fund after any tax-free cash has been paid must be taken in one or a combination of two ways called “secured” pension and “unsecured” pension. For those who delay taking a retirement income until age 75 there is a further option called “alternatively secured pension”.

Drawing your pension
You can now draw your pension and continue to work. Previously, you were not allowed to take a pension from an employer while you were still working for it unless you were a low earner. And finally for the first time, all members of occupational schemes will be able to take out personal pensions alongside their company plans.

Secured pension


A secured pension will provide income for life, either by purchasing an annuity or via a pension paid directly from the pension scheme (a “scheme pension”). However, you can now select either an annuity guarantee period of up to 10 years or a new ‘value-protected’ annuity – basically a more generous version of a guaranteed annuity that allows a lump sum to be paid out on death.

With a value-protected annuity, if you die before age 75 your pension pot is returned to your estate less any income that has already been paid out and 35 per cent tax. However, if you die after 75, your pension will still revert to the insurer.

Unsecured pensions


Unsecured pensions income can be paid in two ways, either by income drawdown or short-term annuities. The new rules have made income drawdown – which allows you to keep your pension fund invested until 75 while drawing an income directly from the fund – more flexible. After the age of 75 separate rules apply.

There is no minimum level of income – you can choose to take none at all, if you wish – and the maximum income is increased to 120 per cent of the income you could get from an annuity. Existing income drawdown pensioners can switch to the new income levels from 6 April 2006.

Short-term annuities will allow a member to purchase an annuity, or a series of annuities, with all or part of their fund. The annuity payable cannot be paid for more than five years or up to age 75 if earlier. Under both options income can be taken from the fund until the member reaches age 75 after which income must be secured by either a scheme pension, a lifetime annuity or by the following route:

Alternatively secured pension (ASP)
ASPs are an alternative to annuity purchase only open to those aged 75 and over. ASPs are effectively a more limited version of drawdown. Under ASP your money will remain invested, and you can draw down an income equivalent to 70 per cent of the return you could receive from an annuity.

When you die any remaining pension fund is used to provide a pension for dependents. If there are no dependents it is possible to pay the value of the plan to provide pension funds for other members of the pension scheme nominated by the member, say friends or family, or to a registered charity. It is expected that the Government will, however, tax pension funds passed on this way.

Phased retirement


Phased retirement will allow you to take your pension benefits at different dates, perhaps while continuing to work. Benefits may be taken as either an unsecured or secured pension before age 75. All benefits must be used to provide a secured pension or ASP from age 75.

Downsides


Rise in minimum retirement age
Currently you can take your pension from age 50. From 6 April 2010 this will increase to age 55. This means that, if your date of birth is 6 April 1960 or later, you will not normally be able to take your pension until age 55. If you are seriously ill you should still be able to take your pension earlier.

Carry back and carry forward
Up to 6 April 2006 you were able to ‘carry back’ pension contributions in certain circumstances. This meant paying a contribution in the current tax year but treating it as if it were paid in the previous tax year. This enabled you to pay more in the current tax year while taking advantage of unused tax relief from the previous year. This ‘carry back’ is no longer allowed.

Commercial property borrowing limits
The amount you can borrow to buy commercial property with your pension fund fell on 6 April 2006. Previously you could borrow 75 per cent of the value of the commercial property but now you can borrow only 50 per cent of the value of your annual pension fund.

SIPPS


Self-invested personal pensions open doors to a much wider choice of investments than the older personal pension plans that tied you to the funds offered by just one provider. A SIPP is a personal pension with flexible investment options – a wrapper around a collection of investments. Unlike stakeholder pensions, many of which are based on general managed funds, SIPPS allow you to hold individual shares, bonds, gilts, commercial property (but no residential property except via a fund), real estate investment trusts (REITS) and unquoted shares. There are many SIPPS providers with different charges depending on how much flexibility you want in terms of the underlying asset invested in. The Financial Services Authority (FSA) will start regulating SIPPS from April 2007.

Need for expert advice


This article provides only a brief summary of the more important changes that the Government intends to introduce over the next few years. It is based on our current understanding of the legislation. It should not be treated or relied on as a statement of law or of providing any advice. We strongly recommend that you speak to  financial adviser before you make any decisions about your retirement provision. If you do not have a financial adviser, you can call 0800 085 3250 for a list of three independent financial advisers local to your area. You will normally have to pay for financial advice.

 
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