FM5 - Pension simplification

The Chancellor confirmed that pensions simplification will go ahead. However the changes will not be introduced until the 6 April 2006. This is the second twelve month delay that has been imposed since the first Consultative Document was published in December 2002 and reflects the Government’s recognition that administration and understanding of the changes will take more time than originally expected.

As of the 6 April 2006 (A-Day). the eight current pension regimes will be swept away and replaced by a single universal regime. There will be two key controls in the new regime as follows:

An annual allowance; and

A lifetime allowance.

Under the new regime, individuals will be able to invest the lower of £215,000 or their earnings into a tax privileged pension arrangement. This annual allowance will increase step-wise between the fiscal years 2007/2008 and 2010/2011 to £255,000.

The lifetime allowance for the first year, 2006/2007, will be £ 1.5 m. This, in turn. will increase over the next four years as follows:

2007/2008 £1.6m

2008/2009 £1.65m

2009/2010 £1.75m

2010/2011 £1.8m

If pension benefits exceed the lifetime allowance, there will be a 'recovery charge' equivalent to 25% of the fund (and further tax up to a total of 55% if taken as a lump sum).

Individuals will be able to protect their existing schemes provided that they register their intent to do so within three years of the change.

Primary protection will enable individuals to register a higher fund which will be expressed as a percentage of the lifetime allowance at the date of the change. Thereafter, they will be entitled to a similar percentage of the lifetime allowance when their scheme vests.

Enhanced protection will ring fence all existing schemes and no further benefit, accruals or contributions will be allowed.

Tax-free cash at vesting will be the same percentage of the fund as it was at A-day.

Peripheral to the tax changes the scope of pension scheme investments will be extended to allow residential property and works of art although it is understood that borrowing will be restricted to 50% of the assets in the scheme which is less generous than the current rules.

Changes will be made to the rules governing pensions in payment. Firstly. those who enter into drawdown schemes will be able to release their tax-free cash although they will only have to take £1 of annual income thereafter. Furthermore, capital protected and limited term annuities will be introduced. Finally, whilst funds cannot be transferred into an individuals estate after they reach the age of 75, they will be able to continue drawing down under the concept of "alternatively secured income" which has been introduced to suit those investors who do not like pooled funds.

The changes are to be welcomed as, eventually, we will have a simplified regime. However, during the transitional period, individuals will have to look carefully at their pension funds going forward and consider whether they should be:

– Registering for some form of protection;

– Re-underwriting existing life contracts under the pension regime; or

– Increasing their contributions if they are currently capped.