Don’t Talk to me about Pensions

The truth is that pensions have a bad name. This is unfortunate as they are the innocent victims of government tinkering and legislative patchwork, coupled with poor investment returns and falling annuity rates over the last 20 years. After all a pension is only a set of rules, another investment vehicle and wholly innocent.

The good news is that things have changed. The patchwork has been replaced by a straightforward new set of rules. The pension plans are flexible with transparent charges, and the investment choice is enormous. Gone are the onerous exit penalties and there is no longer any compulsion to buy an annuity at any age.

It all changed on 6th April 2006 or ‘A-Day’. Here is a synopsis of the main changes, which is by no means exhaustive. As always you should seek professional advice in this area of planning.

Lifetime allowance

This is the maximum value of one’s pension fund(s), without the possibility of a tax charge (‘recovery charge’) when taking benefits is £1.6 million (2007/2008 tax year). This figure rises each year to 2010.

The value of your pension funds will be calculated in different ways, depending on what type of pension arrangements you currently have. The value of personal pension plans, retirement annuity contracts and money purchase occupational schemes will simply be their A-Day value. Pensions in payment will be multiplied by 25 to obtain their value. For final salary scheme members, the accrued pension will be multiplied by 20. Income drawdown plans in payment will be given a capital value by multiplying the maximum permitted withdrawal by 25.

If the total value of your pensions is already over £1.6 million or you think that it could reach this figure, the Inland Revenue may apply a recovery charge of up to 55% on the excess.

There are two ways that you will be able to protect the value of your pension benefits from this tax charge. These are known as ‘primary’ and ‘enhanced’ protection:

Primary protection – this is available for those who want to register a higher lifetime allowance at A-Day. Registering for primary protection will provide the individual with a personal lifetime allowance (PLA) which will be a percentage of the statutory lifetime allowance (SLA - £1.5 million in 2006/2007). Individuals will have 3 years after A-Day to apply for primary protection.

Enhanced protection – this type of protection is designed to help individuals protect both their PLA and future investment returns where they believe that these might outperform increases in the lifetime allowance. No further pension contributions are permitted after A-Day in this case.

Tax-free cash

Everyone is now able to take the lower of 25% of their pension benefits or 25% of the lifetime allowance as tax-free cash. Pre A-Day rules may reduce this percentage depending on the pension scheme.

Annual Allowance

You are able to claim tax relief on contributions up to 100% of your earnings (or £3,600 if lower) and your employer may receive tax relief no matter how much they pay. However, there will be tax charges applied to you where the total amount of contributions paid for your benefit exceeds the annual allowance. The annual allowance is £225,000 (2007/2008) and is due to increase to £255,000 by 2010.

These limits are much more generous than anything previously permitted.

Minimum Retirement Age

From April 2010, the minimum retirement age will be increased from 50 to 55.

Taking Benefits

The new rules allow you to take your benefits in one of four ways:

1. Income withdrawals. This will suit those people who don’t require their entire fund to be used to purchase a pension or require a flexible form of income in retirement. This will only be available until age 75. This will be very similar to the current Income Drawdown facility although the minimum income can be £0 pa.
2. A guaranteed annuity income.
3. An income paid directly from the pension scheme such as a company pension.
4. An alternatively secured pension, although this option is less attractive due to the 2007 Budget.

We hope that the above has provided a useful insight into some of the main changes.

The McDevitt Partnership provides advice on all types of retirement planning solutions, from traditional annuities; investment linked annuities, income drawdown, phased retirement and phased income drawdown. Retirement planning is part of your overall financial planning picture. We will treat it as such and not in isolation. This is true professional financial planning.

That said, pension options are a complicated area and here are just some of the things to consider.

• Personal income tax position
• Tax free cash
• Flexibility of income
• Death benefits
• Investment risk
• Guaranteed annuity rates
• Open market options
• Impaired annuities
• Spouse’s pension
• Level or escalating benefits
• Guarantee periods
• Payment frequency

Summary

In general annuity purchase is the popular choice due to the guaranteed nature of future income stream. However annuity purchase is a once only decision; there is no turning back, and the loss of death benefits associated with annuity purchase is still a common gripe. There are of course ways to counter this with simple life assurance, good health and satisfactory underwriting permitting.

People who do not need to rely on the guaranteed income of an annuity have ultimate flexibility in post retirement planning. They can choose the assets they want to invest in, the amount of income they wish to receive each year, combining this with income from other sources to try to achieve maximum tax efficiency. Death benefits are still available, but with all this come additional costs of ongoing administration and advice.

Annuities are under pressure with falling rates not only due to falling interest rates but also the advent of impaired life rates, improved mortality, and medical advances. The fact is we are living longer and those who are not are effectively being removed from the annuity pool by choice, thus lowering the “cross subsidy” enjoyed by so many healthy annuitants over the last century.