‘A’-day represents a landmark day in pensions legislation. Effective from the 6th April 2006 the current complicated and fragmented pensions regime will be swept aside in a radical change to retirement planning.

In December 2003, two joined up pieces of thinking, the Department of Work and Pensions ‘simplicity, security and choice – working and saving for retirement’ and the Treasury paper ‘Simplifying the taxation of pensions: increasing choice and flexibility for all’, detailed structural changes that were required in the UK long-term savings market.

Various Government reports and committees have culminated in the Pensions Act 2004 and Finance Act 2004 which taken together represent a significant change to UK pensions legislation. The overall aim of the legislation is to encourage savings by simplifying the pension regimes and rules, making it easier for private and occupational pension schemes to be understood.

This radical plan for the UK pensions and long-term saving system is being introduced to address the following key issues:

? Reduce the complexity of options available on pensions
? Provide greater investment freedom on the underlying pension funds
? Create enthusiasm and return confidence for long-term savings
? Most importantly reduce the £27bn long-term savings gap

The changes will fundamentally impact on how benefits are taken, will introduce potential tax charges on pension funds and restrict how affluent individuals save for their retirement.

Let us consider what will be the immediate impact on how much you can contribute and have retained in a pension fund.

The Allowances

? The proposals introduce the concept of a Lifetime Allowance for tax privileged pension savings. This will be the accumulated value of your pension portfolio and will be valued at certain points during your lifetime.

The value of this Allowance will be initially set at £1.5m for the tax year 2006/07 and will replace all current pension limits. The Government has given assurances that the Allowance will rise to £1.8m until 2010/11. Thereafter it is widely expected that subsequent increases in the Allowance will be limited to an inflation index.

? The proposals also introduced the concept of tax charges on pension funds. The new rules state that pension benefits that have been accumulated over the Lifetime Allowance may be subject to a significant recovery (tax) charge. This tax charge will be as high as 55% of the excess.

? Contribution rates have also changed and a further concept introduced; the Annual Allowance for tax privileged pension savings. This will be set at £215,000 for 6 April 2006 and will replace the current pension limits. As with the Lifetime Allowance, the Annual Allowance will increase at a predetermined rate until 2010/11, and then it is expected that the Allowance will be increased by an inflation rate.

These new allowances will enable most people to catch up on previous years when contributions may have been limited. You can also re-structure your payments to ensure that funding takes place during years of high earnings, reducing your potential liability to income tax.

Now we have considered the amounts that can be contributed to pensions, we need to consider the planning opportunities under these new rules. The three opportunities highlighted deal with the following specific issues.

? The concept of the ’family’ Self-Investment Personal Pension (SIPP) and residential property purchase
? Borrowing allowances to fund wider investment opportunities
? How to protect your pension fund from these tax charges.

The family SIPP and residential property purchase

From April 6 2006 it will be possible to hold residential property in the tax shelter of a SIPP, borrow against the fund to make the purchase, and pass the property to children. But they must have a SIPP with the same company and share the same underlying trust deed.

It will be essential to ensure that property and other tangible investments are appropriate to your SIPP portfolio, and to assess the likely complexity and level of any tax charges that may arise where the intention is to make personal use of the assets.

In particular, if a SIPP fund buys a residential property that family members use as a permanent or holiday home, then it will be necessary to pay a commercial rent to the fund, or a benefit-in-kind tax charge to the Revenue worth 40% of the rent that would have been paid.

And there is a limit to the tax-free nature of such transfers. Under the new regime your fund at vesting will be assessed against the Lifetime Allowance. Any excess over this allowance that is not ring-fenced by the forms of protection described later, will be subject to a tax charge.

Borrowing allowances

The funding of the property purchase is a key consideration. You will be able to invest more in approved pension arrangements from April 2006, when it will be possible to contribute up to 100% of earnings, capped at £215,000 in 2006-2007.

However, the new borrowing rules will be less attractive than the current rules for the presently allowed commercial property purchase. At present it is possible to borrow 75% of the value of the property but after A-Day it will be possible to borrow only 50% of the value of the accumulated fund.

This means that a SIPP fund worth £200,000 could be used before A-Day to purchase a property worth £800,000, but this will drop significantly to just £300,000 after the new regulations are in force.

How can I protect my pension fund?

There are two main types of protection, enhanced and primary. Each has different rules and provides different degrees of protection against these changes. It is crucial that claims for protection are addressed as a high priority in order to take advantage of the protection provided, and thus benefit from a reduced or nil tax liability on the ultimate benefits.

Prior to reviewing the protection available, you will need to determine the value of your accumulated pension fund. To value your pension fund you will need to include the fund value of any money purchase type arrangements and use predetermined scales for converting pensions in payment and deferred benefits in ‘final salary’ type pension arrangements to a cash value equivalent.

Primary Protection

Primary protection allows you to protect some of your pension rights from the lifetime allowance tax charge. This protection is only available if your pension rights are worth more than £1.5m on 5 April 2006.

The effect of primary protection is to give you a personal lifetime allowance higher than the standard lifetime allowance. This increase is expressed as a percentage over and above the Allowance. If you elect primary protection you will be permitted to pay further contributions to, or accrue additional benefits in, a pension scheme after A-day.

Enhanced Protection

You can register for enhanced protection regardless of whether the value of the pension fund exceeds £1.5m on A-day. Enhanced protection will deliver complete freedom from the lifetime allowance charge on the existing accumulated fund.

In the case of a defined benefit scheme, whether enhanced protection is retained at retirement is subject to more complex rules. If this is chosen, benefit accrual must cease by 06 April 2006.

Combining Protection

Where funds prior to A-day exceed the Lifetime Allowance, it is possible to select both Primary and Enhanced Protection. This will provide maximum flexibility, although you will need to cease active membership of any pension scheme. You are able to ‘give-up’ your enhanced protection rights. The fund would then continue to benefit from Primary Protection if further pension contributions are required.

The Implications of Protection

The main implication of choosing protection will mean that pension funds are reviewed to establish how they fit into your overall financial plans. One impact of selecting protection could be to restrict the amount of future increases your pension fund could enjoy without suffering a tax-charge. Alternatively, you avoid any tax charge and thereby restrict your investment choice and family planning opportunities.

Summary

In the short-term retirement planning will become anything but simplified. Sound financial decisions need to be made now to ensure that future tax charges are avoided and that the fund can achieve wider financial objectives. No longer can a pension be viewed as a standalone ‘product’ that can be left until you stop or reduce your drawings.

Planning for these rule changes needs to takes place as a matter of urgency. There is a great opportunity to use the new rules to change the shape and design of your pension scheme but a limited time to plan.

Care should however be taken before making irrevocable decisions, since despite the tight deadlines many details of the legislation remain to be finalised. My strong recommendation would be to plan now, but defer implementation nearer to A-day when the full detail of the legislation in known.

With careful nurturing your pension fund could thrive and blossom under these new rules.

Stuart J. Grennan
Executive Director
Heath Lambert Consulting Limited

Heath Lambert Consulting Ltd arranges financial services products and is authorised and regulated by the Financial Services Authority. Registered Office: Friary Court, Crutched Friars, London EC3N 2NP. Registered No: 0772217