Countdown to Ecstasy
I’m sure the Steely Dan fans out there thought this article might be something to do with the excellent 1973 album, but alas, it is more to do with A-Day, next April. For the war veterans, this is not a memorial day, but the day when we will see the biggest shake-up in pensions legislation in almost a century.
The Glaswegians among you may all ask "whit's it all about then?" Well our Government, along with much input from the industry professionals have decided, quite rightly, that the way pensions are administered is far too complex and ungainly.
Named A-Day by the Inland Revenue, April 6 next year is when the present eight sets of rules for different kinds of pensions will be scrapped and replaced by a single set covering every pension plan in Britain. Experts are calling it the most radical overhaul since the old-age pension was introduced in 1908.
Many people will benefit, being able to contribute more into their pensions and buy into a wider range of investments, including residential property. But there could be losers too. Make the wrong decisions and you could be taxed at 55%.
Over the next 2 months, I am going to suggest ways to help you make the most of A-Day.
What should you do if you are in a company pension scheme?
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.
However, if you find that you are near to retirement, you may want to delay retiring until after A-Day to take advantage of the more favourable benefits that come into force 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 that you would be better off.
If you have used additional voluntary contributions (AVCs) to top-up your company scheme, with you will also be able to take 25% of the AVC fund as a tax-free sum. Under the present rules, 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 pension department for details.
If your company scheme has opted out of the state second pension, which used to be known as Serps, the rules will also become more generous. 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 you will need to ask them about their plans.
The tax on larger pensions. Can you avoid it?
The government is introducing a limit on the maximum value of your retirement fund. This is called the lifetime allowance and it will be set at £1.5m in April 2006, rising to £1.8m by 2010. If you have several 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.
This means, if your fund is worth £1.6m and the allowance is £1.5m, you would pay tax at 55% on the £100,000 excess. This would mean a charge of £55,000.
You need to ask your pensions department or the insurance company running your pension to estimate what your fund is worth now, and what it’s likely value will be in April and at retirement, to see if you are in danger of breaching 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, most advisers 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 types 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.
Registering for protection probably isn’t a good idea unless you are certain that you will breach the allowance, because you will lose the right to make contributions. Without labouring too much in the first part of this subject, I will conclude this month’s chatter here. Next month, I will be looking at contribution levels and some of the very exciting new investments that can be included in your pension arrangement. I know, you can hardly contain yourself, but it will be worth it.
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