UK: Preparing for A-Day – How Will the New Pension Rules Affect You?

Last Updated: 6 December 2005
Article by Andrew Goldstone

Mention pensions to most people and they either yawn loudly or turn purple with rage. But 6 April 2006 (or "A-Day" as it's being called) heralds an exciting new era in pension planning and many of the wide-ranging changes are good news. Some people won't be affected but most high earners will. We have summarised the main changes and if you think they might affect you, now is the time to review your pension and take any necessary steps to protect it before A-Day.

What are the new rules?

The aim is to have a single set of rules applying to all pension schemes. The key changes are as follows:

  • Lifetime allowance: Penal tax charges will apply to pension savings above the "lifetime allowance". In 2006 the lifetime allowance will be £1.5m rising each year up to £1.8m in 2010. Sums over the lifetime allowance will be taxable at up to 55%.
  • Annual limit on contributions: The new rules on contributions are very generous. You will no longer be limited to a fraction of capped earnings. Instead you can contribute up to 100% of your earnings up to a maximum of £215,000 per year and still get full tax relief. This figure will rise each year up to £255,000 in 2010. Your employer can also make contributions as long as the combined total does not exceed the annual limit. Any contributions over the annual limit will not qualify for tax relief.
  • Tax-free lump sum: When your pension matures you will be able to receive a tax-free lump sum of 25% of your pension fund (up to the lifetime allowance). There will be winners and losers. Some existing schemes currently offer less than 25% as tax-free cash. Others offer considerably more and in those cases it may be possible to keep the higher entitlement by transferring to a different type of pension before A-Day.
  • Investment flexibility: From A-Day you can include a wide range of investments in your pension. However, and contrary to original hopes, for many people that will not extend to residential property and other "exotic" assets. The Pre-Budget Report has announced that "self-directed" pensions such as self-invested personal pensions (or SIPPs) will not be able to invest directly in residential property (including buy-to-lets and holiday homes), wine, classic cars, antiques and racehorses etc without paying a penal tax charge. That is a major change of policy by the Government and a disappointment to many.
  • Borrowing limits: Currently a SIPP can borrow up to 75% of the purchase price of a commercial property. After A-Day the borrowing limit will be restricted to 50% of the pension's value. Unless you have a large pension pot, it will be much harder to borrow enough to finance a reasonable property purchase without liquidating the SIPP's other investments and putting all your pension eggs in one basket. If you are considering buying commercial property through your SIPP, you should think about doing so now while the borrowing limits are higher. You should also consider re-financing existing uncompetitive loans now as re-financing after A-Day will be treated as a new loan and caught by the new lower limits. Even if you agree a new loan before A-Day, unless it's actually drawn down before 6 April 2006 it will be too late and you will be restricted by the new lower limits.
  • Protecting existing pensions: Fortunately the government has allowed two concessions to protect valuable pension rights built up before A-Day. The first is Primary Protection. It allows those with pension funds over £1.5m on A-Day to register the actual fund value as a percentage of the lifetime allowance and receive a lifetime "enhancement factor". So if the pension is worth £3m on A-Day, the enhancement factor is 200% and if the lifetime allowance rises to £1.8m then the enhanced lifetime allowance is 200% of £1.8m i.e. £3.6m. Alternatively, Enhanced Protection is available provided you pay nothing more into your pension. This ensures the eventual value of your pension will be exempt from further tax however much it grows to, which may be the right choice if you think your pension investments are likely to increase rapidly. You can always subsequently waive Enhanced Protection if you later decide to make further contributions.
  • Other changes: The minimum retirement age will increase from 50 to 55 by 2010 with only limited exceptions. You will no longer need to give up work to access an occupational pension and if the scheme rules allow it, you can even carry on working for the same employer whilst drawing pension benefits. Death benefits can be in the form of a lump sum, a pension to one or more dependants or a combination of both.

What should you do now?

  • If you have spare cash and your pension fund is already close to or over the £1.5m limit, consider adding to it (within current contribution limits) before A-Day and then making a claim for Primary or Enhanced Protection. This will allow you to protect the largest possible fund.
  • If you are aiming to retire before 6 April 2006, consider delaying your plans so that you can make a large contribution into your pension fund in your year of retirement post A-Day.
  • If you are considering buying commercial property in the near future, bear in mind that the permitted borrowing limits will be severely reduced post A-Day.
  • If your current tax-free lump sum entitlement is over 25%, take advice on how to preserve it post A-Day.
  • Organise any refinancing of existing SIPP commercial property loans before A-Day.

Whether you want to protect your current pension pot or look into new investment opportunities, it's a good idea to take professional advice before 6 April 2006. Although simplified, the new rules are far from simple. We can advise you how to take best advantage of the opportunities available and how to avoid hidden pitfalls. If necessary we can put you in touch with suitable pension experts.

This article is only intended as a general statement and no action should be taken in reliance on it without specific legal advice.

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