Retirement Planning

With effect from 6th April 2006, commonly known as ‘A Day’, the various pension regimes encompassing personal pensions, occupational pension schemes and additional voluntary contributions merged into one. There are now, therefore, no differences in respect of allowable contributions, the effect of the lifetime allowance and tax free cash entitlement on benefits accruing from 6th April 2006.  Transitional relief may be available to protect benefits accumulated up to 5th April 2006 if these are more advantageous than under the new regime.

There are still differences, however, in respect of how the schemes are administered with personal pensions still offering, in many cases, a simpler version than the more complex occupational pension scheme.  The additional administrative burden may result in scheme trustees transferring from occupational to personal pension in some cases although, as always, independent financial advice is highly recommended to ratify such a proposal.

Outlined below are some of the key points of which you should be aware: -

Contributions

Individuals can contribute up to £3,600 or 100% of their earnings if more each year and claim tax relief up to £235,000 (applicable during tax year 2008/2009). Personal contributions above 100% of salary up to £235,000 may be made with no tax relief given. Above £235,000, a tax charge of 40% will apply. Employer contributions may be made to any level although a 40% charge will apply on the employee above £235,000. There is no contribution limit at all in the year in which benefits are taken in full.  Automatic Corporation Tax relief on employer contributions has been removed with the ‘wholly and exclusively for trade purpose’ test introduced to decide whether relief will apply.

Self employed contributions are based on “current year” profits not historical data.  This raises a problem where profits are not known or volatile.

Tax Benefits

Investment in a pension plan continues to offer tax advantages in that tax relief is available on contributions and growth is largely tax-free.

Lifetime Allowance (SLA)

A statutory lifetime allowance applies of £1.65m (2008/2009) rising to £1.8m by 2010/11.

Excess funds will either be taxed (called the Recovery Charge) at 55% if taken as cash, or 25% if income (then subject to likely 40% Income Tax).  The net effect is, therefore, the same.

Two methods of protection are available, namely Primary or Enhanced Protection, and both types require individuals to register with the Inland Revenue within three years of 6th April 2006.

Final salary pension benefits will be included at £20 to £1 of income to determine the value against the SLA, or 25:1 if pensions are already in payment (to allow for cash already taken).

Tax Free Lump Sum

The amount of tax-free cash available from all money purchase schemes will be 25%.  Policyholders with a greater than 25% tax free cash entitlement from an Executive Pension Plan (EPP) up to 5th April 2006 must be able to prove this by way of an audit trail, otherwise this will revert to 25%. 

NB:     Any client with an EPP needs this checking by a financial adviser prior to 5th April 2009!

Early Retirement

Benefits can be taken from a pension between the ages of 50 and 75, although from 6th April 2010 the minimum age will be 55.  It is now also possible under the new pension rules to defer purchasing an annuity beyond age 75.

Retirement Income

“Capital protected” annuities are available providing the options of “money back on death’ (purchase price of annuity less pension instalments paid out, less 35% tax).

Personal pension fund withdrawal, often known as income drawdown, is now called Unsecured Pension (USP).  These plans are not available after age 75 but the ability to avoid purchasing an annuity at that point is offered by Alternatively Secured Pension (ASP).  This is similar to drawdown whereby the fund remains invested.  However, since ‘A Day’, further legislative changes have occurred, resulting in the imposition of penal tax charges for this type of arrangement thus, as a consequence, it is unlikely to be attractive to a majority of clients.

Investments

Contrary to their previous intentions, the Government now treats residential property, as well as personal chattels such as art, antiques and fine wines, as ‘prohibited assets’ if held within a pension scheme.  This effectively stopped this potential investment opportunity, which had attracted huge media attention and client interest, dead in its tracks.

If someone places their own private residence, buy to let property or holiday home in their pension, the tax consequences are severe.  Although tax relief is available at outset, there is, on the otherhand, a tax penalty of up to 55% on the member and an extra 15% on the scheme administrator (the fund itself) equating to 70% in total!  Additionally, it is our understanding that income and gains resulting from a prohibited asset will not be tax exempt. 

The new rules are designed to prevent the potential abuse of acquiring assets from which a personal benefit may be derived rather than the acquisition of assets for the primary reason of accumulating a fund to secure a retirement income.  Basically, this adds up to a clear deterrent to even considering residential property for a pension scheme.

The Government still permits indirect investment in prohibited assets, via, for example, a pooled unit trust or investment trust that may invest in residential property, although the member is clearly unable to enjoy personal or non-commercial use of such assets. 

The following features of pensions have now ceased:

Personal pension and retirement annuity (S226) contributions ‘carry back’ facility has been removed.

The ability to use ‘base year earnings’ has ceased.  This allowed clients to use the best earnings figure from the current and previous five tax years on which to calculate maximum contributions.

Carry forward of unused pension relief from the previous six years has been abolished.