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Steve Bee on Pensions

I am starting to think that people like me in our industry have spent too much of our time concentrating on the way the new pension legislation will impact on the higher-paid people in the UK workforce and not enough time on how the new tax rules will complicate the lives of average pension savers and pension scheme members.

I suppose it was important to start with to focus on where this legislation meets people on edges, particularly on the effect it will have in forcing most of the pension decision-makers in UK plc to leave our pension system for good because of the imposition of retrospective tax charges on pension benefits already accrued. But the impression we have given in pursuing this line is that it is only high earners who will face problems after A-Day and that is simply not true.

These supposed simplifications will, I think, drive more and more people into needing sensible advice regarding their pension options and one area where this seems so apparent to me is in the way that tax-free cash will work in the future.

If you think tax-free cash for money-purchase pensions after A-Day will be 25 per cent of the fund, you are wrong. For many people, it will be nothing like it. The truth is that the tax-free cash from money-purchase pension pots could be anything up to 45 per cent of the fund, depending on the form in which people choose to take their retirement benefits and the age they are when they retire. It could also be limited to 25 per cent for the same reason and I promise I am not making any of this up.

After A-Day, the tax-free cash that people with some forms of money-purchase pensions will be entitled to will depend on the level of annuity rates at the time they retire and the type of annuity they choose.

The money-purchase schemes I am talking about here are both trust-based schemes such as Comps, Cimps, EPPs, SSASs and section-32 plans as well as contract based schemes such as personal pensions, GPPs, stakeholder pensions and group stakeholder pensions or, to put it another way, all money-purchase individual, group and group schemes.

After A-Day, people retiring from money-purchase arrangements will have the opportunity to take their pension benefits in the form of an open-market option (where they effectively shop around the annuity market with their pension pot to get the best deal available) or a scheme pension which is provided by the scheme they are in. The first thing to understand is that where people go for the open-market option and shop around, the new rules say that the tax-free cash is limited to 25 per cent.

But, surprisingly, people who do not shop around and take a scheme pension instead are not going to be limited to 25 per cent tax-free cash by the new tax laws set out in this year’s Finance Act. For them, the tax-free cash varies depending on the annuity rate applied and the type of annuity selected.

The broad rule of thumb is this. Where people select single-life, level annuities as a scheme pension, they will become entitled to more tax-free cash than if they were to select a joint-life annuity with built-in increases.

I calculate that the difference between the two extremes could provide something like twice as much tax-free cash. Also, the older they are when they retire, the more tax-free cash that people with money-purchase pensions potentially become entitled to. Strangely enough, the opposite appears to be the case for people in final-salary schemes where later retirement seems to produce a lower entitlement to tax-free cash.

Average pension scheme members will have some pretty difficult trade-offs to make when they retire from ordinary pension schemes after April 5, 2006. Let us hope that everyone involved in the advice chain has time to gear up to being able to advise them about the effect of these so-called simplifications.

Steve Bee head of pension strategy Scottish Life

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