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 recent 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 The patchwork has been replaced by a straightforward new set of rules.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 inflexibility associated with annuity purchase. There are options at retirement other than buying an annuity.

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

Lifetime Allowance (LTA)

This is the maximum value of one’s pension fund(s), without the possibility of a tax charge (‘recovery charge’) when taking benefits is £1.8 million (2010/11). The Government has announced that the LTA will be frozen and more recently that it will be reduced from £1.8m to £1.5m from April 2012.

The value of your pension funds will be calculated in different ways, depending on the 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 value at the time you take benefits. For final salary scheme members, the accrued pension will be multiplied by 20.

If the total value of your pensions is already over the LTA or you think that it could reach this figure, HMRC may apply a recovery charge of up to 55% on the excess if drawn as a lump sum. Some transitional protection for those with pension values already above the reduced lifetime allowance or who have made plans based on an LTA of £1.8m will be made available. Further protection may also be available for those relying on existing transitional protection rules.

Individuals had three years from A-Day to protect the value of pension benefits from this tax charge. These are known as ‘primary’ and ‘enhanced’ protection.

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 increase 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 currently £255,000 (2010/11).

‘High earners’ with relevant income greater than £130,000, may have tax relief on pension contributions limited by anti-forestalling rules, although these complex rules will only apply until 5 April 2011, when anti-forestalling ends.

A reduced annual allowance of £50,000 will apply from April 2011. In future this may be subject to indexation increases but not until after 2015/16. A form of carry-forward is to be introduced allowing up to three years’ previous unused allowances to be used. The carry-forward limit for 2008/09, 2009/10 and 2010/11 will be £50,000. Full tax relief at the marginal rate (up to 50%) on pension contributions will continue.

Minimum Retirement Age

From April 2010, the normal minimum retirement age for occupational and personal pension schemes increased from 50 to 55.

Taking Benefits

Benefits may be accessed 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 who require a flexible form of income in retirement. This will only be available until age 77. The minimum income can be set at £0 p.a., allowing for total flexibility.
2. A guaranteed annuity income.
3. An income paid directly from the pension scheme such as a company pension.
4. An alternatively secured pension.

We hope that the above has provided a useful insight into some of the current rules and recent changes.

The McDevitt Partnership provides advice on retirement planning solutions, from traditional annuities, investment linked annuities, income drawdown, to 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
• Enhanced 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 the 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 enhanced annuity 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.