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Pensions & A Day


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A Day was 6 April 2006. It marked a major shake-up of pension regulation: eight separate sets of rules were junked in favour of a new, simpler set of regulations. This guide explains how the pension rules work and what they mean for your pension planning.

What was A Day?

A Day was 6 April 2006, the date when 'pension simplification' took effect. This was the introduction of new pension rules, which aim to make pensions easier to contribute to and more flexible to take.

The changes were radical and affect anyone who puts money into a pension. The maximum amount you may contribute to your pension in 2008 / 09 is £235,000. You may contribute more than your taxable earnings but tax relief is only available on pension contributions of up to 100% of your taxable earnings. If you have no taxable earnings you may contribute up to £3,600 gross each year. Your employer may make unlimited contributions to your fund and claim full business tax relief, providing the contribution meets a wholly and exclusively for the purposes of the trade test.

The only other figure you need to take note of is the lifetime allowance (LTA), set at £1.65 million (2008 / 09), which is the maximum size pension fund you may hold without being subject to a tax surcharge, called the recovery charge.

Both the annual contribution limit and the lifetime allowance will increase gradually each year so that, by 2010-11, the annual contribution limit will stand at £255,000 and the lifetime allowance at £1.8 million.

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What is the lifetime allowance?

The lifetime allowance (LTA) is the maximum amount that you may have invested in your pension fund without incurring a tax charge on any funds you draw on which exceed the limit. The lifetime allowance has been set at £1.65 million for the tax year 2008 / 09.

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Should I choose 'primary' or 'enhanced' protection?

This is a very complex matter on which you should seek independent financial advice from an adviser who specialises in pensions.

Primary protection serves to protect the fund already accrued at A Day as a percentage of the lifetime allowance and allows it to grow modestly in line with the annual increases in the allowance, without the fund becoming liable to the recovery charge of up to 55% on the excess.

However, if your fund exceeds the previously determined percentage of the relevant lifetime allowance in the year you retire, you will have to pay the recovery charge.

Enhanced protection is available to anyone, irrespective of the size of their pension. It not only protects the current value of your fund, but allows you to protect any future growth in its value, due to future investment returns or pension benefit increases, without incurring a surcharge.

If you have not already done so, you should register your pension fund for protection with the taxman by 5 April 2009.

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Can I get more tax-free cash on retirement?

It depends on what type of scheme you belong to. Some people may be entitled to higher tax free cash as a result of the A Day changes, others were entitled to higher tax free cash under the pre A Day rules and should have taken steps to protect their tax free lump sum entitlement already.

Since A Day, all schemes are permitted to pay their members 25% of their pension funds as tax-free cash or pension commencement lump sum (PCLS) as it is now known, or a maximum of £412,500 (25% of £1.65m).

Because of the various ways that final salary schemes calculate members' PCLS entitlement, 25% of the fund after A Day may be more advantageous for some, but not for others.

Those who were better off under the pre A Day rules are likely to be 'pre 1987' members of final salary schemes and members of low benefit occupational money purchase schemes.

If you were entitled to more than £375,000 pre A Day (25% of the then lifetime limit), you should have protected your lump sum by registering for primary or enhanced protection.

If your entitlement post A Day is less advantageous than under the pre A Day rules, but the amount involved is less than £375,000, you do not have to register it with the taxman. Instead your scheme administrator was required to make a record of the fact that you were entitled to more than 25% tax free cash just prior to A Day.

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What's in pension simplification for those with low or no savings?

If you are a low or non earner, you will be able to save up to £3,600 a year into a personal pension with automatic tax relief at the standard rate of 20%, even if you are a non taxpayer.

Even if you have little disposable income now and so cannot make large contributions at the moment, you may be able to do so later in your career. The new rules encourage 'late starters' to make up for lost time by giving people the opportunity to make very large contributions towards the end of their working lives.

In addition to the higher annual contribution limits (£235,000 in 2008 / 09), both you and your employer can make unlimited contributions to your fund in the year you retire, although you will only get tax relief on contributions you make on up to 100% of your salary.

You may also continue contributing to a pension after age 75, although such contributions will not attract tax relief and you won't be able to take a tax free lump sum, unless you start drawing on your pension fund before age 75.

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I belong to a company pension scheme. Can I save elsewhere?

Post A Day you are allowed to contribute to as many different pension schemes as you like. So, if you belong to a company scheme, you could pay extra contributions to any other type of pension scheme, such as a personal pension or a SIPP. Remember, however, you will only get tax relief on up to 100% of your earnings and that contributions are subject to the annual contributions limit and the value of your total pension funds is subject to the lifetime allowance.

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What can I invest my pension savings in after A Day?

Since A Day, you may invest in a wide range of investments with a Self Invested Personal Pension (SIPP), such as mutual funds, equities, bonds, insured funds, investment trusts, gilts, commercial property, private equity, hedge funds and unquoted shares.

Some residential property is allowed but only if bought as part of a syndicate of at least 10 people, and provided that you meet other strict criteria, such as strictly no personal usage.

You may invest in commercial property, albeit with a lower gearing limit post A Day of 50% of your pension fund's net value (compared to 75% of the purchase price as previously applied).

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What happened to the State Second Pension (S2P) and AVCs?

You may take up to 25% of your State Second Pension (S2P), the earnings related top-up pension to the State scheme, as tax-free cash. S2P replaced a similar scheme known as the State Earnings Related Pension Scheme (SERPS) in 2002, and is also referred to as the 'rebate only' or 'protected rights' pension. Previously S2P could only be taken as income.

Another change is that you will be able to take these S2P benefits from age 50, whereas previously you had to wait until age 60. That said, the minimum age for taking all pension benefits including S2P will rise to 55 in 2010.

For those who have made additional voluntary contributions (AVCs) since 1987, there is further good news. These can be taken as 25% tax-free cash whereas previously they had to be taken entirely as income via an annuity.

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How can I take my pension at retirement?

If you are a member of a final salary pension scheme, the scheme rules and trustees will dictate how your pension is provided. Those who wish to transfer company scheme benefits to a personal pension, such as a SIPP, in order to do income draw down (known as Unsecured Pension) will generally find this easier to do.

However, you should only transfer out of a company scheme after having taken independent financial advice as you could lose valuable benefits impossible to replicate via a personal pension.

If you have any form of personal pension (including group personal pensions and stakeholder pensions) you have two options. You may either take up to 25% tax-free cash, using the balance to purchase an annuity on the open market or you may take an 'Unsecured Pension'.

The latter is the post A Day form of income draw down, whereby you can take up to 25% of your fund as tax-free cash and leave the balance invested. You may then take an income, if you wish each year, of between zero and 120% of what a level, standard annuity would pay to someone of your age.

The crucial difference between an Unsecured Pension and the previous income draw down rules is that you are no longer obliged to take any income each year.

After age 75, you may continue doing a more restricted form of income draw down, called taking an 'Alternatively Secured Pension' or ASP. This allows you to take an annual income of between 55-90% of what a standard level annuity would pay a 75 year old, however old you are. This means that your income will not rise in line with your age.

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Do the rules help people who have lots of tiny pension funds?

Since A Day you are able to take any number of small pension pots as cash at retirement, instead of having to use 75% of these funds to purchase tiny annuities.

You can do this on condition that you meet three criteria: you are at least age 60; the total value of these 'trivial pensions' does not exceed 1% of the lifetime allowance (£16,500 in 2008 / 09) and you take them all within a 12 month period. However, only 25% of the cash can be taken tax free. The remaining 75% will be taxed at your marginal rate.

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Are there any changes to annuities?

Insurance companies may now offer a wider range of annuities to help people take their pensions in a more flexible way. For instance, there are more limited period annuities on offer, whereby you purchase an annuity for a specific number of years (typically 5 to 10) rather than for life.

Money back annuities, also known as value protected annuities, can also be bought. When you die, they pay out to your heirs the purchase price (the amount originally handed over to the insurance company when you bought the annuity) less any payments made up to the date of death and less 35% tax. But these annuities only pay out if you die before age 75.

Alternatively, you may buy a 10 year guarantee which will ensure that the annuity payments continue to be made for a minimum of 10 years.

Annuity rates can vary up to 25% between annuity providers. Let us help you find the right annuity for you.

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26 March 2008 © Moneyextra.com

 

Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.