New pension choices for all

From April 6^th next year we will all be much freer to decide how much we save for our retirement, how we invest what we do save, and how we use those savings to give us a pension in retirement. Although the changes will not start for some months, they are on the whole so good that in most cases it is worth considering putting off retirement until after they begin on what the Government calls ‘A-Day’.

Paying into a pension
From A-Day you will be able to pay a lot more in to a pension. Each tax year you will be able to put in a sum equal to your entire gross earnings in the year from a job or self-employment. There is an upper limit of £215,000 though that will not bother most of us. The change will mean that people who want to give their pension a boost in the final years before retirement will be free to do so without worrying about the complex rules that apply now. They limit you to 15 per cent of your gross pay into a company scheme or between 17.5 per cent and 40 per cent of your pay into a personal pension depending on your age. In future, if you are given a redundancy payment or inherit some money then it will be possible to pay the whole lot straight into your pension fund as long as you do not pay in more than you earn in the year or breach the £215,000 limit. And in the tax year you retire there are no limits. You can pay any amount into your pension and get tax relief on the amount up to your annual earnings.

The limit will apply to your total contributions to any pension – company or personal – so even if you have a company pension you will probably still be free to put more into a personal or stakeholder pension if you wish. The limit includes the contributions paid by your employer as well as your own and it will rise by £10,000 a year until it reaches £255,000 in 2010/11.

People under 75 who have no earnings at all will still be able to put up to £3600 a year into a stakeholder pension as they can now. That contribution attracts tax-relief – even if they pay no tax – so it actually costs £2808 with the remaining £792 paid by the Government.

Tax-free cash
One of the benefits of saving up for a pension is the freedom to take out some of your pension savings as a tax-free lump sum. It is win-win – you pay in the money before tax is deducted and then you take some of it out tax-free. However, there are currently many rules and restrictions that limit this freedom. From A-Day all those rules will in theory be replaced with just one – you can take 25 per cent of any pension fund tax free.

For almost everyone that will be good news. At the moment you cannot take any tax-free cash out of most additional voluntary contribution schemes – where you pay into an extra pension on top of your company scheme – which you began after April 1987. The same applies to a pension bought with National Insurance contributions you saved by ‘contracting out’ of paying into the State Earnings Related Pension Scheme (SERPS) or, as it is now called State Second Pension (S2P). But if you wait to retire until after A-Day you will be able to take 25 per cent of either tax-free.

In theory a few people who have paid into the same pension for more than seventeen years could have a right to a higher lump-sum than 25 per cent. In practice, that will be very rare today. If you think that may apply to you, get advice. In some case you can preserve those rights.

Although the new rules should give everyone a right to a lump sum of a quarter of their fund, the calculation for people in schemes that give them a pension related to their pay was described to me by one expert as ‘nose-bleedingly difficult’. In general you will be able to take more cash tax-free but it will cost you a much bigger chunk of your pension – maybe cutting it by a third if you take the maximum tax-free cash. So get figures for the pension with various amounts of tax-free cash and think carefully about the choices.

Small and large pensions
There will be a useful new rule for people with only a small amount of money saved up for their pension. If the total value of all your pension savings is £15,000 or less – the Government calls it a ‘trivial pension fund’ – then you will be able to take it all out in cash. A quarter will be tax-free and the rest will be subject to tax at your normal rate in the year you draw it. So if your income is going to be lower in retirement it may save you money to retire near the beginning of the tax year. The limit will rise to £16,000 in 2007/8 and to £18,000 by 2010/11. Remember that the total value of all your pension funds – including the value of any company pension entitlement – has to be less than the limit. To find the value of a salary related pension due in the future multiply the annual pension by 20. If the pension is already in payment multiply it by 25.

At the other end of the scale there will be a new restriction on the total value of a pension fund when you retire. In 2006/07 this limit or ‘lifetime allowance’ will be £1.5 million and that amount will rise to £1.6 million in 2007/08 and then each year to reach £1.8 million from April 2010. That may seem a lot of money – about sixty times the typical pension fund – but people with very well paid jobs and good salary related pensions could find they breach the limit. The ‘value’ of a salary-related pension will be twenty times the annual payment. So a pension of more than £75,000 a year will be deemed to be worth more than the £1.5 million limit in 2006/07.

If your fund exceeds the limit the excess can be taken as cash – but tax of 55 per cent will be deducted first. Alternatively the extra money can be converted into a pension, in which case 25 per cent is deducted from the capital and the income is taxed at 40 per cent.

People whose pension is worth more than £1.5 million before A-Day can protect it. If you are in this fortunate position you should see a financial adviser or discuss the matter with your company pension scheme administrator as soon as possible.

Retirement
You don’t have to stop work to ‘retire’. You can retire and draw a personal pension at any age from 50 to 75. With many personal pensions you may have picked your retirement age many years ago when you started the pension plan. In some cases you have to stick to that date or risk financial penalties. Check with your plan provider or the financial adviser who sold it to you. Even if you nominally ‘retire’ and draw your pension you can still carry on working as long as you like.

At the moment if you draw a company pension you cannot go back to work for that company. But from A-Day that restriction will disappear. You will be able to draw your pension and carry on working for the same company, even in the same job, is that is what you and your employer want.

From April 2010 the minimum age to draw a pension will be raised from 50 to 55. That new minimum age will also apply to sports professionals and others who currently can take pension benefits younger than 50. However, if you currently have the right to take retirement before 55 you may be able to preserve it for benefits earned before A-Day. See an adviser soon.