The Government is slowly re-introducing complexity to the great simplification of pension rules which begins on the sixth of this month. Two new restrictions were announced by the Chancellor in his pre-Budget statement before Christmas. And the pages of detailed guidance and clarification get longer by the day – one insider estimates there are now 3000 pages of them on the Revenue website. Nevertheless, the new rules are still a lot simpler than the old ones and give people much more flexibility in how much they can save and what they can do with it.
Most people can now pay what they like into a pension. There are just two main rules. First, you cannot put in more than you earn in the year from work or self-employment. Second, you cannot pay in more than £215,000 in a tax year. That limit will rise in stages to £255,000 by 2010/11. If you have an employer that includes any contribution they make.
There are two exceptions to these rules. Even if you have no earnings at all, you can pay in up to £2808 a year to which the Chancellor will add £792 in tax relief – even if you pay no tax – making a total of £3600 a year. Second, in the tax year before you decide to take all the benefits out of your pension the upper limit on savings doesn’t apply. That year you can pay in as much as you like, more than you earn and more than £215,000 if you have that much. So if you inherit money or get a redundancy payment you can put a big lump into your pension. Though you will not get tax relief on more than you earn in that year.
This new system means that you can get a tax boost to your pension even on money you do not earn. Suppose you are 60 and earn £22,000 a year. You have no pension. You inherit £80,000 from your aunt. You put in £22,000 from your inheritance. Or rather you put in £17,160 and the Chancellor tops it up with £4840 tax relief. Over the next three years you put in the maximum you are allowed, £17,160 with £4840 tax relief from the Chancellor. At the end of that process you have put £102,564 in your pension fund, if the money has grown at 5% a year you will have £120,000 in there. You can take up to a quarter of it out tax-free, which will give you a nice lump-sum of £30,000 and now you are 65 the £90,000 left will buy you a pension of around £6000 a year for life.
The Government has stepped in to stop what it calls abuse of this generous new system. Suppose in the above example you took out your £30,000 lump sum and immediately used it to pay into another, new personal pension. That could generate more tax relief. You would get £8461 added on by the Chancellor. And it is even better if you were earning say £40,000 rather than £22,000 and thus paid higher rate tax. Then you could also claim back another £6923 in higher rate tax relief. So you would have used your tax-free £30,000 from one pension and created more than £38,000 in your new pension at a cost to you of around £23,000. And, in either case, if you wanted you could then ‘retire’ and take out a quarter of the pension fund – around £8000 - tax-free. You could then use that £8000 to start another pension, and so on. This re-use of tax-free lump sums to get extra tax relief is called recycling and the Government has stepped in to stop it. Or at least stop what it calls ‘abuse’ of the rules.
You can still get away with recycling as long as you fulfil ANY of these four conditions.
The total amount of pension lump-sum you take in a year is £15,000 or less.
Your increased contributions into a pension scheme are no more than a fifth of the lump-sum.
Your annual pension contributions do not increase by more than "a significant amount" which guidance suggests will be a fifth.
You did not intend to recycle when you took out the lump-sum.
This last condition is a sort of get-out clause. If you take out the lump sum to spend or keep or invest but later realise the joys of recycling, you are free to recycle it. Proving your innocence might be difficult. Especially now you have read these paragraphs!
SIPPs
The other big change in the rules, announced just four months before they
began,. was new restrictions on self-invested personal pensions or SIPPs. These
are pension schemes where you, the pension beneficiary, make the crucial
decisions about what is in the pension fund rather than leaving that to a fund
manager. Until the Chancellor stood up on 30 November the finance industry was
gearing up for a new and lucrative kind of pension invested in property or works
of art. We had been told that from April this year SIPPs would no longer be
restricted to shares, unit trusts, bonds, gilts and all the traditional safe
fare of pensions. Instead anything could be put in and most of these anythings
were not regulated. Companies were formed to sell property in Bulgaria, stamps,
fine wine, even Royal Doulton figures, into SIPPs.
Although these changes were seen as useful deregulation, there were fears that many wealthier people who did not need a pension would use the SIPP mechanism to acquire property and gain full tax relief on it and on any income it produced. After much pressure from the press, pensions experts, and the more respectable parts of the industry itself, the Chancellor took far stronger action than anyone expected and effectively banned all these quirky new investments. SIPPs can still contain shares, bonds, gilts and so on. But property, coins and veteran cars are out.
Some people anticipated the April changes and bought a house or put down a deposit on one expecting that their pension fund could then buy the property off them once the new rules began in April. Some may find they have entered into a contract they will now find hard to fulfil. Others may make a loss. But they will normally have to bear these costs themselves. If they took advice from a regulated adviser or company based in the UK they may have a claim against them. But it will be a hard road.
Trivial amounts
If the total value of all your pension savings is £15,000 or less you can
take it all in cash. A quarter will be tax-free and the other three-quarters
will be added to your income and taxed. The limit will rise to £16,000 in 2007/8
and to £18,000 by 2010/11. The total value of all your pension funds, including
ones that you do not want to draw yet, has to be less than the limit. Any
company pension is included too. If that is a pension fund that you use to buy a
pension then find out what it is worth. If it is a salary-related pension you
must work out its value by multiplying the annual pension it promises by 20. If
the pension is already in payment multiply it by 25. So a pension in payment of
£400 a year is ‘worth’ £10,000 and if your other pension funds are worth more
than £5000 you will not be able to take them in cash.
Working on
You can now draw your pension and carry on working for the same employer. At
least, you can as far as the Government is concerned. But two things might stop
you being able to do it in practice. First, employers can fix their own
retirement age. From 1 October that age cannot be less than 65. But at the
moment if your employer has a retirement age of 62 and your pension only pays
out at 62 then there is little you can do if your employer will not let you work
past that age. Even if your employer is happy for you to stay on, there may be a
second problem. Your pension scheme will have its own rules about drawing your
pension and many will not allow you to take your pension and carry on working
for the employer. So even though the Government no longer prohibits it, your
pension scheme may still not allow it. Many schemes will probably change their
rules over the next few years but it might be time to start lobbying the
trustees now.
April 2006