A-Day is the date new pensions legislation comes into force and will revolutionise the way we think about pensions. The proposed changes in pension rules will have an impact on people planning for their retirement.
All those planning for retirement or advising others on their retirement plans should be aware of the implications of A-Day.
Stuart Royston, Chief Executive of Life Academy, explains the history leading up to where we are today, and gives an overview of the key changes A-Day will bring.
PENSIONS – AN INTRODUCTION
In recent years pensions have been front page news and frequently because of difficulties that have arisen. There are some fundamental problems. The principal problem is the demographic changes that are taking place in the UK and many countries in Western Europe. People are living longer and it costs more to provide pensions for a longer timescale. This is particularly relevant to individuals and employers providing final salary (defined benefit) schemes. The birth rate has also fallen with the result that there are fewer younger workers coming into the workplace. This has implications for state retirement pensions which are unfunded. For companies the fundamental demographic problem has been made worse by the poor investment returns achieved by pension funds at the start of this decade and at a personal level individuals are not saving enough for their retirement. The Department for Work and Pensions estimates 10 million individuals are at risk of not having adequate pension provision.
The Pensions Commission, which was appointed by the Government to examine the issues and make recommendations, has generally advised that individuals should work longer, save more (or pay more tax towards their retirement) or face poverty in old age. The Government is encouraging individuals to work longer and make informed choices about their pension savings. Companies are responding to the increased cost of pensions by closing defined benefit (final salary) schemes in favour of defined contribution schemes which transfer the risk of achieving an adequate pension to the individual.
‘A DAY’: 6TH APRIL 2006
On 6th April 2006, changes to pension and annuities take effect. The basic idea behind the new legislation is to harmonise and simplify the different rules for different types of pension schemes. The eight tax regimes will be reduced to one and this should reduce the cost burden on employers and pension providers and make life simpler for individuals. In the light of the problems outlined above it is not surprising that for individuals most of the changes provide greater flexibility and choice over saving for a pension.
THE MAIN ‘A DAY’ CHANGES
Contributions to a pension
The limit on how much you can pay into a pension based on your age and earnings is swept aside and replaced by a much simpler annual limit. You will receive tax relief on 100% of pension contributions up to a maximum of £215,000 (which will rise by £10,000 p.a. to £225,000 by 2010/2011). There is no limit on how many different types of pension you can have but there is a Lifetime Allowance limit on your pension fund of £1.5 million in 2006/07 rising to £1.8 million by 2010/2011.
Taking your pension
From 6th April, you’ll be able to draw a pension from your employer's pension scheme and carry on working for that employer. This will give you the opportunity to phase your retirement, allowing you greater flexibility as well as giving your employer the benefit of your experience for longer.
Everyone will be able to take a 25% tax free lump sum from their pension regardless of the type of scheme. Before ‘A Day’ some pension schemes allowed you to take more while others, such as AVC schemes, did not allow you to take any tax free cash.
You will also be able to take a pension fund of less than £15,000 in cash and spend it on whatever you please. If you have more than one pension it is the cumulative fund total that must be under £15,000. 25% is tax free and income tax is payable on the residual 75% at your marginal rate of tax.
There will be more flexible options about purchasing an annuity. Many individuals will continue to purchase an annuity when they retire but you no longer need to take all your benefits by the age of 75 although after this age you can only take benefits as income. If you want a tax free lump sum you must take it before you reach 75.
Income Drawdown was introduced ten years ago and was used by some individuals with large pension funds – typically at least £100,000 or £200,000. Income Drawdown will still be available under the new name of ‘Unsecured Pension’. At age 75, conventional annuity purchase is still an option. There are other options – Limited Period Annuity (annuities that run for 5 years and use part of your pension fund with the remainder invested) or Alternative Second Pension – similar to remaining in drawdown. In this area you may wish to seek independent financial advice.
To find out more visit the FSA’s website, www.fsa.gov.uk/consumer/pensions.
