Memorandum on New Pension Rules

Pensions became much simpler to understand, following some important changes to the tax rules that were introduced on 6th April 2006 (sometimes called A-Day). The aim of this letter is to explain the main changes. As Chartered Accountants we can give independent and unbiased advice on future pension strategy whether you are an employer, an employee or you are self employed.

The new rules do genuinely have the simplifying effects that the Inland Revenue intended. But a few aspects have turned out to be very complex, and in some cases are so crucial that you may need to make a reappraisal of your financial planning strategy.

First, there are some key aspects of pensions that have not changed:

• Pension contributions qualify for full tax relief. 

• The contributions are invested in a fund that accumulates free of UK tax on investment income and capital gains, although pension funds cannot claim the tax credits on dividends from UK shares. 

• Part of the pension fund can be taken as a tax free lump sum and the rest as taxable income for life. 

• Life assurance can be provided under pension plan rules and the premiums are allowable for tax. 

The changes mainly affect how much can be contributed to pensions and the limits on the benefits that can be withdrawn from them. The new rules will generally apply to all pension schemes regardless of when they were set up.

Maximum contributions

There will be a big increase in the maximum you will generally be allowed to invest into your pension each year. You will be able to contribute up to 100% of your earnings. Your employer may be able to contribute more and the overall annual limit will be £215,000 in 2006/07 and will rise in later years. Even if you have no earnings, you will still be able to invest £3,600 a year before tax relief.

Maximum fund/benefits 

Everyone will have a maximum permitted tax-exempt fund (or its equivalent in retirement benefits). This will be called the lifetime allowance.  In 2006/07, it will be £1.5 million and will rise in later years. Any benefits you have built up before 6 April 2006 can be protected, but proper advice needs to be taken on this aspect.

Tax-free lump sum  

The maximum tax-free will be 25% of the fund. Most people will therefore end up with more tax-free cash when they retire, but a few will get less than they might have done under the current rules. There are also special provisions that can protect rights to excess tax free cash built up before 6th April 2006.

Carry back of contributions 

There will no longer be any carry back of pension contributions allowed. This point could be important, particularly for self employed people that relied on this facility.

When you can retire 

The earliest age at which most people will be able to retire will rise from 50 to 55 on 6th April 2010. Flexible retirement will be encouraged by allowing people to carry on working for employers while receiving a pension from the same employer’s scheme.

Death benefits before retirement 

The maximum lump sum death benefit under the new pension rules will be the lifetime allowance, ie £1.5 million in 2006/07 - normally free of all tax.

Income in retirement  
When you come to draw your retirement benefits, the main options will be very similar to the current choices - but with a few important changes.  If you are a member of a group scheme, you will probably receive a scheme pension paid out by the scheme itself.  If you have an individual scheme such as a personal pension, you may receive a secured pension - in the form of a lifetime annuity.  You might want to take an unsecured income such as withdrawals directly from your pension fund. These will operate very much as they do now; for example they must stop at age 75. But you will be able to take a new option – an alternatively secured pension. This is a restricted form of pension fund withdrawal that could provide some limited death benefits.

Investment rules
The restrictions on pension investment by self-invested schemes will be generally liberalised. In particular it will be possible to buy residential property. You could even live in it - subject to a tax charge. But the rules on how much such pension schemes can borrow - eg to buy property – will be tightened up. The amount that such schemes can lend to their sponsoring employers will also be more restricted. 

Penalties for exceeding limits

 Penalties will be higher than at present, eg for exceeding the lifetime or annual allowances.

Action checklist

• If you are thinking of retiring before 6th April 2006, consider deferring if it would mean getting higher tax free cash or more flexibility.  

• It may be worth taking specific advice if it looks as if your pension benefit will be near or above the £1.5 million level on 6th April 2006.  This advice should be taken well before that date. 

• If your tax free cash at 6th April 2006 might exceed £375,000 you should take advice about safeguarding it under the complex special rules. 

• Review the investment strategy for your self-invested pension scheme.  

• Explore the scope for borrowing by your pension scheme before the new restrictions start to apply. 

• Loans from the pension scheme to the sponsoring employer should be considered now. 

• Think about the ways you want to draw your retirement benefits.  

• You should review any unapproved schemes of which you are a member.  The rules for these are also changing.   

• Review your life assurance. You may well be able to qualify for full tax relief on premiums arranged under the new rules. 

• Employers should review all their pension arrangements and rules. 

• Since the carry back facility will no longer be available it is vital that the level of contributions you wish to make is paid in the tax year. This will particularly affect self employed people, or those on variable incomes, where they have perhaps been used to making a lump sum contribution by 31st January each year in order to mitigate their tax liability. For example, it has been a useful facility to cover higher rate tax where the amount involved may not be known until after the tax year. From a tax planning point of view it may be necessary to get in touch around January or February each year in order that we can assist in helping to predict income levels so that the necessary lump sum contribution is made by March each year.

 Timescales are relatively tight, so you should get advice as a priority.  

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