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Sipp shape

I have been reading about Government plans to simplify pensions. How will this affect my pension, in which I have £390,000, with around 10 years to go before I want to take benefits?

The money is currently invested in a self-invested personal pension and I am thinking about buying a property with the fund. What do you advise?

The final decisions have yet to be made on pension simplification but we expect to hear more in the March Budget. The Chancellor has asked the National Audit Office to research the impact of the proposed £1.4m lifetime allowance and a decision about whether or not to introduce changes will be made when this is completed. We are also waiting for the publication of a Department for Work and Pensions document setting out its proposals for change.

At this stage, therefore, the answers to your questions are subject to change. However, if simplification is introduced as proposed in the recent document from the Treasury and the Inland Revenue, we can say the following.

At the moment, the investments allowed in your Sipp are subject to the rules laid out in a statutory instrument published in April 2001 with the snappy title Personal Pension Schemes (Restriction on Discretion to Approve) (Permitted Investments) Regulations SI117.

It is proposed that from A-day, probably April 6, 2005, there will be one set of investment rules for all pension scheme investments.

One of the proposed changes is of real interest – it may be possible to invest a pension fund in residential property. This has not hitherto been possible but it has always been a popular enquiry. After years of saying: “No, you cannot buy a residential property with your Sipp,” it may soon be that the answer is yes.

What is more, you might be able to buy a residential property with your Sipp and live in it. This will be subject to a tax charge similar to the way in which employees are taxed on benefits in kind. It might still be attractive to some people to do this.

Sipps have been able to borrow for the purpose of commercial property purchase and they will still be able to do so in the future. However, the amount of borrowing will be lower as the maximum allowed will be 50 per cent of the value of the Sipp fund at the date of borrowing rather than the current 75 per cent of the purchase price.

Carryback will be abolished. It will no longer be possible for a contribution to be paid up to January 31 and then for an election to be made to carry the contribution back to the previous tax year for tax purposes. Instead, contribution limits will be much simpler and the lower of £200,000, your total earnings or £3,600 gross will form the maximum contribution you can pay to your Sipp and receive income tax relief.

So, rather than a system based on your age attained at the start of each tax year and a relevant percentage of your earnings, contributions will be much simpler to work out. It will still be the case, however, that existing pension income and income from investments, such as dividends, will not count towards the definition of income.

You will have to be careful that your total pension fund does not exceed the new lifetime allowance of £1.4m. If it does and you then take the benefits, anything in excess of the limit will be available to you as a lump sum but it will suffer a penal tax charge of 55 per cent. This will be made up of a recovery charge of 25 per cent and 40 per cent income tax, giving the effective rate of 55 per cent.

At retirement, you will have to decide how to convert your pension fund into income. You can, of course, choose to purchase an annuity if that is the right thing for you.

If you make provision for a surviving spouse through a guaranteed minimum payment period, then note that under the new regime it will be caught in the tax net and the capital value of the balance of the five years&#39 pension payments will be taxed at 35 per cent. Currently, such payments are free of income tax.

We all hope that when the DWP issues its proposals, we see the allowance of protected rights funds inside Sipps, the availability of such benefits from age 55 rather than 60 and tax-free cash of 25 per cent applying to them. We shall see.

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