Now much of the fuss has died down over the Chancellor’s announcement on residential property in self-invested personal pensions, it is time to review what is left from the proposed simplification changes due this April.
One of the areas about to change substantially is how a member can draw benefits.
Most members take their benefits by applying the secured income rules. These rules include a scheme pension where the scheme provides an income t the member, often via an annuity, and a lifetime annuity where the member buys the annuity.
An interesting new option is the protected annuity. This gives members’ beneficiaries a return of the initial capital less pension payments made, subject to a tax charge of 35 per cent.
Next is the unsecured income option. This looks similar to what we know as income drawdown but there will be a few changes such as there will be no minimum income level to be taken, maximum income will be 120 per cent of the Government Actuary’s Department rate and income reviews will be made every five yearsThe ability to buy short-term temporary annuities is also to be introduced. These can be bought for a maximum term of five years and may appeal to individuals who want to avoid buying an annuity with their entire fund but who would rather have their income provided via a less volatile method than drawing it directly from the fund.
The most fundamental change to the rules around taking benefits is the introduction of the alternatively secured pension. This compares with unsecured income in several ways:
- It is only available from 75 and there is no minimum income level that must be taken.
- The maximum withdrawal is 70 per cent of the GAD rate for a 75-year-old and income levels are reviewed annually.
- There is no option for a lump sum less 35 per cent to be passed to dependant. The residual fund upon death must be used to provide a dependant’s pension, if a dependant exists, in the form of an annuity, drawdown or alternatively secured pension.
- Upon a member’s death, if no dependants exist, then the fund can be passed to other members of the same scheme, with possible inheritance tax implications.
A lifetime allowance will replace all current benefit limits and is the total value of pension savings to have benefited from tax relief when contributions were made. When a pension fund is crystallised – the new term for when a pension is drawn – the value of an individual’s pension arrangements being crystallised are totalled and tested against the lifetime allowance. Any amount above the lifetime allowance will be taxed at 25 per cent if taken as pension income – which is then subject to income tax – or taxed at 55 per cent if taken as cash. This is called a recovery charge. In 2006/07, the allowance has been set at 1.5m, rising to 1.8m in 2010/11.
Members who have accumulated substantial funds in the current regime and have yet to begin taking benefits should consider enhanced protection to shield them from the recovery charge although this means they will no longer be able to make any further contributions.
This is particularly relevant as HM Revenue & Customs has confirmed that it intends to introduce in the Finance Act 2006 a second benefit crystallisation event – an event which triggers a lifetime allowance check – when a member goes into an alternatively secured pension at 75. This means that a member could be tested twice against the lifetime allowance.
For members who have selected enhanced protection, HMRC has confirmed that there will be no benefit crystallisation event when a member designates funds to unsecured income, an alternatively secured pension or buys an annuity so long as the provisions of enhanced protection are maintained. Given the potential tax charge, many will regard this as the best way forward.
For members who are already in income drawdown, it appears that this group is protected from the recovery charge, provided that no new assets are crystallised to provide an income.
Providers with existing drawdown arrangements at A-Day have two years to bring these in line with the new limits. One piece of good news is that drawdown holders can move to the minimum income level (0) immediately on April 6, 2006.
There is also likely to be a new set of GAD tables with the new regime. HMRC has issued a consultation document on these, with the consultation having ended on December 31, 2005. For some groups of people, this does mean that the implied increase in maximum income from 100 to 120 per cent of the GAD rate may not actually materialise. The document itself quotes examples of the maximum annual income under the current and new regime.
Finally, it would be inappropriate to talk about retirement options without commenting on the IHT implications. It was initially anticipated, following the consultation document issued by HMRC on July 21, 2005, that we would have some further guidance by the end of December. Unfortunately. this is yet to appear although Chancellor Gordon Brown stated in the pre-Budget report that legislation will be introduced in the Finance Act 2006 to clarify how IHT will be applied under the new regime.
What HMRC has stated is that the “relatively light touch” it has adopted on IHT and pensions will no longer apply. Unfortunately, it appears that HMRC’s new assumptions are likely to affect not only those using the new alternatively secured pension but also under-75s who have “omitted to exercise an option” by not drawing benefits when they could do so.
All this leads me to conclude that pensions are too complicated. Someone