Pension Planning |
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Take advantage of new pension rules By Hannah Ricci
Taking 25% of your pension fund as tax-free cash is just one of the new pension rules that came into force on 6 April 2006 - dubbed A-Day. The Government transformed eight different tax regimes into one streamlined system, with However, very few people have taken advantage of the changes. Industry research found that 60% of us are completely unaware of the A-Day pension reform and only 8% have sought professional advice on our pension since the changes were announced. While the new rules were heralded as pension simplification, many of us, including experts, are struggling to get our heads around the changes. Contribution limits Probably the most dramatic change is the amount we can now contribute to pensions. Previously, the amount depended on the type of pension you had, with maximum contributions ranging from 15% of your income, in occupational pension schemes, to 40% if you were over 61 or had a personal pension. Since A-Day, there are just two factors determining contribution limits: an annual allowance and a lifetime allowance. These will both increase year on year, but the annual allowance is currently set at 100% of your earnings, up to a maximum of £225,000, while the lifetime allowance is currently £1.6 million. But the change is great news for many savers. Jonathan Watts-Lay, director of JPMorgan Invest, says a lot of people are looking at their pension pots and realising they don't have as much as they expected. So how can we benefit from the increased contribution allowances? Watts-Lay says: "As well as being able to boost your pension pot with savings and investments, such as individual savings accounts, few people know that under the new rules it is possible to transfer the value of share save incentive schemes offered by employers into a pension scheme - and receive tax relief." Although transfers into an occupational pension scheme may not always be permitted, it won't be a problem with personal or stakeholder pension schemes. Help for younger savers The flexibility created by the annual allowance is also good news for younger people. Starting a pension is rarely a top priority for those in their twenties, but now there is scope to catch up when finances aren't so tight. The ability to transfer savings and investments is also a bonus for this age group. "You can build up tax-free savings in an ISA, for example, and wait until you receive a pay rise or promotion further down the career path, which takes you into the higher rate tax band, before transferring your savings into a pension pot with tax-relief at 40%," explains Watts-Lay. Lifetime allowance Those who are nearing retirement or have been making sizeable contributions need to check where their pension contributions are in relation to the lifetime allowance of £1.6 million. Any pension fund in excess of the lifetime limit will be subject to a new tax known as the lifetime allowance charge, which could be as high as 55%. Fortunately, this doesn't affect everyone who has already built up a large pension pot that either already exceeds the lifetime allowance or is set to by retirement. However, if this is you, you will need to protect the excess. There are two forms of protection: 'primary', which is only available if your fund is already in excess of £1.6 million, and 'enhanced', which can be used whether you are above or below the lifetime allowance. You will need to apply for the correct protection, but this can be quite a complex area, so Fairs suggests seeking advice from an IFA. Tax-free cash Under the new rules, everyone has the option of taking up to 25% of their pension fund as tax-free cash, which can help create a much more flexible and fulfilling build-up to retirement. This means retirement needn't be a sudden end to your working life and you can use the tax-free cash to tailor it to suit you, says Francis Klonowski, partner at financial planning consultants, Klonowski and Co. in Leeds. Some people are taking their tax-free cash and reinvesting it, but Klonowski generally advises against this. "Providing your pension fund is a balanced portfolio of equities, fixed-interest, cash and property, it's really not worth taking money out just to invest elsewhere," he says. And you don't have to take the full 25% - this is just the maximum amount. Think about how much you need to meet your objectives. "If you want to reduce your working hours, for example, think about how much income you will receive and the kind of lifestyle you want to determine how much to draw down to make this work," explains Klonowski. The new rules also allow what is called 'immediate vesting personal pensions,' which allow anyone aged between 50 and 74 to recycle their pension contributions to maximise the tax relief. For example, if a higher-rate tax payer put £600 into their pension, tax relief at 40% would turn it into £1,000 while 25% could be taken straight away under the 25% tax-free cash rules. Four reinvestments could effectively double the initial investment without taking any risk, but there is a catch. You cannot reclaim more in tax relief in one year than you've paid in tax, which means, for it to be effective, a higher-rate tax payer would need to earn at least £70,000. Drawing your pension Up until A-Day everyone had to buy an annuity by age 75 as a way of receiving income from a pension fund. This is still the case, but now there is another option called an alternatively secured pension (ASP). An ASP is a form of income drawdown that allows you to invest your pension savings and draw an income from it within set limits. The main advantage over annuities is being able to maintain control of your savings. While annuities provide a guaranteed income until death, which can be transferred to a nominated spouse or dependant, after they die the fund is lost to the annuity provider. ASPs allow you to transfer any residual funds after the death of you and your spouse to another generation. Unfortunately, the Government made a very swift u-turn following A-Day, making ASPs less attractive. "The chancellor confirmed in his budget in March that ASPs will be subject to several taxes," says Klonowski. ASPs will be classed as part of the estate, which means transfers on death will be subject to inheritance tax and an unauthorised payment charge of up to 70%. However, Klonowski says we shouldn't turn our back on ASPs because of this. "Don't be panicked into buying an annuity because of the u-turn with ASPs. They still have benefits, and it's important to seek independent financial advice to help you make the right choice for you." Tom McPhail, head of pensions research at Hargreaves Lansdown, agrees: "While ASPs are no longer a way of passing on an inheritance, due to the tax implications, they can still give investors the flexibility to draw and manage their money in retirement."
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