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A-day action

Standard Life head of pensions policy John Lawson says that with A-Day just weeks away, taking stock of pension plans now will reap rewards later. The rules are simple but making the transition will be complex, which is where advisers come in

With only weeks to go until new pension tax rules come into force, people with an occupational pension should take stock now. There are situations where some advanced thinking will pay real dividends.

Take protected rights savings. These are savings built up in an occupational money-purchase scheme or a personal pension through contracting out of the state second pension or its predecessor, Serps.

Current rules mean that you have to buy a pension with all your protected rights’ savings but from A-Day, you can take 25 per cent of these savings as a tax-free lump sum.

People approaching retirement should therefore consider deferring the decision to draw their protected rights fund until after A-Day.

A similar change applies to additional voluntary contribution savings and free-standing AVCs. Like protected rights, current rules say that you must take all your AVC savings in the form of a pension. Again, the new rules will allow 25 per cent of your AVC and FSAVC savings to be taken as a tax-free lump sum from A-Day.

People with money-purchase AVCs built up alongside a final-salary pension can take more than 25 per cent of their AVC savings tax-free because new tax rules combine AVCs with your final-salary pension when calculating the maximum tax-free lump sum.

This is potentially a very big win for members of final-salary schemes because a tax-free lump sum is presently only available by giving up part of the final-salary pension. The amount of pension given up in return for a lump sum depends on the scheme’s commu-tation rate. A typical comm-utation rate is 12 to one.

In other words, you must give up 1 of pension for every 12 of lump sum but each 1 of pension from a typical final-salary scheme is worth around 29 at age 60 or 25 at 65. Giving up 1 of pension worth 29 and getting 12 in its place does not make good financial sense.

Thankfully, the new rules will allow you to take all your tax-free lump sum from your money-purchase AVC pot, where 1 of fund equals 1of lump sum. But there is a catch. To make this possible, the trustees will have to change the pension scheme rules. People with money-purchase AVC savings alongside a final-salary pension should put pressure on the trustees of their pension scheme to make this member-friendly change in time for A-Day.

Most people with a money-purchase occupational pension (not a personal pension, a group personal pension or a final-salary pension) are likely to have a right to a tax-free lump sum of more than a quarter of their retirement fund. As many as 80 per cent of the three million people with such a pension could have this right.

To ensure that no one loses out, Revenue & Customs allows you to protect this entitlement. All you need to do is make sure that your pension scheme trustees have details of your earnings in the tax year ending April 5, 2006, together with the date on which you joined your employer. Those who have already left employment should give the trustees details of earnings in the last year of employment.

The new pension tax rules allow you to build a fund up to a lifetime allowance of 1.5m (tax year 2006/07, rising to 1.8m in 2010/11). However, the penalties for exceeding the limit are severe. Although you can take any excess as a lump sum, a tax charge of 55 per cent applies.

People who already have a fund of over 1.5m or a final- salary pension worth at least 75,000 (a final-salary pension is valued at 20 times the amount of the pension) should therefore consider claiming both primary and enhanced protection.

Primary protection is only available to those with a fund (or a pension worth) of at least 1.5m on A-Day. It protects the value of your pension pot up to the rate of growth of the lifetime allowance. For example, if you have a fund of 1.65m at A-Day, when the lifetime allowance is 1.5m, your personal lifetime allowance is 110 per cent (1.65 m/ 1.5m) of the standard lifetime allowance.

If you then retire with a fund of 2.18m in 2010, when the standard lifetime allowance is 1.8m, you can take 1.98m (110 per cent of 1.8m) without paying an extra tax charge. The remaining 200,000 will be subject to a 55 per cent tax charge (110,000) if you take it as cash or 25 per cent (50,000) if you take it as income.

Enhanced protection protects the whole of your fund, regardless of how quickly it grows. But to get this form of protection, you must agree not to make any new pension contributions after A-Day. Using the above example, enhanced pro- tection protects the whole fund of 2.18m from the additional tax charge.

Unlike primary protection, enhanced protection is also available to those with less than 1.5m at A-Day, who think that their pension fund will be higher than the lifetime allowance by the time they retire.

To claim primary protection, enhanced protection or both, a form needs to be completed from Revenue & Customs and you must send it back no later than April 5, 2009. But remember that those claiming enhanced prot-ection also need to stop paying contributions (or building up more final-salary pension) by April 5.

Although the new rules are simple, the transitional issues can be complicated.

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