FOOL SCHOOL
A-Day: The Future Of Pensions

December 21, 2005

6 April 2006 is what is known as A-Day for pensions. This is the date when new pension legislation comes into effect. If you've got a private or company pension you may need to do something about it now, otherwise you could lose out.

Those people who intend to retire over the next few years will be most affected. Some may be better off taking retirement benefits before A-Day, while others would gain from waiting until the new regime comes in.

The overriding thrust of the new legislation is to sweep together all the different rules we currently have for different types of pension scheme. At this time we have eight different sets of pension rules meaning that, for example, the amount you can contribute each year is different depending on whether you're in a defined benefit scheme or a defined contribution scheme.

The main changes can be summarised under six headings:

1) Retirement age

The minimum age at which you can start taking your private or company pension will be raised from 50 to 55 by April 2010. The same age limit will also apply to some groups (e.g. some sportsmen) who are currently able to take their retirement benefits from as young as 35 years old.

Impact: Those wanting to retire early might find other routes, such as ISAs, become more attractive. Those in groups that currently have a low retirement age may want to get cracking and draw their benefits prior to A-Day.

2) Annual contributions

You'll be able to put in up to the lower of your annual earnings or £215,000 in the 2006/07 tax year and still get tax relief. The maximum limit will be increased by £10,000 each year until it reaches £255,000 in 2010/11.

Everyone will be able to put in a minimum of £3,600 a year, as they can now, so you'll still be able to contribute to a pension even if you're not earning.

Impact: Most people will be able to put more into their pension than they do at the moment, assuming of course that they can afford to do so.

3) Big pension pots

This is arguably the most complex area of the A-Day changes. There will be a Lifetime Allowance of £1.5m for 2006/07. This means that if the value of your fund exceeds this amount and you retire in 2006/07, any excess will be taxed at punitive rates of up to 55% (although this partly reflects the fact you've received tax relief of up to 40% when contributing to your pension in the first place).

The Lifetime Allowance will increase to £1.6m in 2007/08 and then by £50,000 each year until 2010/11, when it will be £1.8m.

The amount of people that will be hit by this limit has been disputed. It will be fairly small but, to put it in perspective, £1.5m will provide for an inflation-proofed joint income of around £60,000 at current annuity rates.

Impact: If you're lucky enough to have a pension that might exceed £1.5m, you'll be most affected by the changes and you'll probably need some financial advice. However, you will be able to register with the Inland Revenue any pension you've amassed prior to A-Day, which will partially protect it from the additional tax rates.

4) Small pension pots

Currently, all pension pots of more than £2,500 have to be used to purchase an annuity. However, from A-Day, you'll be able to take up to 1% of the Lifetime Allowance in cash. So, in 2006/07, if all your pension pots total less than £15,000, you'll be able to take the whole amount in cash. In addition, up to 25% of this cash will be available tax free. This option will be available to people between the ages of 60 and 75.

Impact: If you've got a small pension pot that you're about to convert, it might be worth hanging on until after A-Day.

5) Tax-free lump sums

Everyone will be able to take up to 25% of their pension (up to the Single Lifetime Allowance) as a tax-free lump sum.

Impact: Although some old pension plans allowed more than 25%, the biggest change here is likely to be for those who have made Additional Voluntary Contributions (AVCs). Currently, you can't take AVCs as a tax-free lump sum so it may be worth delaying taking these benefits until after A-Day if you're nearing retirement.

6) Pension income

The requirement to take an annuity by age 75 will no longer exist. You'll have the option of taking an Alternative Secured Income instead, which may mean you'll be able to pass on any unused pension after your death. However, you will still have to take an annual income from your fund, which will then by taxed. The minimum amount will be £1 a year and the maximum will be linked to annuity rates.

In addition, there will be two new types of annuity - the Limited Period Annuity and the Value Protected Annuity. The former lasts for just five years, after which time you can buy another one, or a normal lifetime annuity. The latter will pay out any unused amount to your heirs, but you'll get a lower income than a normal annuity.

Finally, if you're in a company pension scheme you will no longer have to retire in order you draw your pension. So you can continue working but also begin to take some or all of your pension benefits.

Impact: Those about to take an annuity may want to wait for the new types to arrive and investigate the Alternative Secured Income option.

In conclusion

Although the aim of the new legislation is to make pensions simpler, the transitional period to the new regime come be rather painful for some of us. Those with the smallest and largest pension pots are those who will be most affected but even for those in the middle, especially those around retirement age at the moment, a little forward planning could be very rewarding.

> Find out more about pensions.