Pension Tax Simplification introduces a radical new tax regime for pensions which will take effect from 6 April 2006. This day has been named ‘A-Day.’ Simplification will sweep away the eight exisiting pension tax regimes and replace them with a single universal regime. The whole idea of pension simplification is to encourage more and more people to save for their retirement. The new rules will allow people to have much greater control over where their monies are invested, and will give them more flexibility when taking benefits.

The main changes can be summarised under seven 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, i.e. prior to age 55, might find other routes, such as ISAs, become more attractive so that they can use the proceeds of the ISAs prior to taking benefits from their pension/s. Those in company pension schemes that currently have a low retirement age (i.e. below age 55) may consider it beneficial to draw their benefits prior to A-Day.

2) Annual contributions:

At the moment, the amount you can contribute is dependent on your salary and your age, up to a maximum of 40% of your gross annual income (after age 60) but after A-Day, you'll be able to put in up to £215,000 in the 2006/07 tax year. The maximum limit will be increased by £10,000 each year until it reaches £255,000 in 2010/11. The annual allowance will then be reviewed every five years. 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. However, that's subject to the next point.

3) Big pension pots:

This is the change that has occupied the most headlines. It is also the most complex. There will be a Standard Lifetime Allowance for the first five years after 5 April 2006 are as follows:

• 2006/7 - £1.50 m,
• 2007/08 - £1.60 m,
• 2008/09 - £1.65 m. - £1.75 m.
• 2010/11 - £1.80 m. It is not yet know what the Lifetime Allowance will be after 2010/11.

If the value of your fund exceeds this allowable limits, 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).

Impact: If you're lucky enough to have a pension that might exceed £1.5m, you may possibly 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 1% of the Lifetime Allowance in cash. So, in 2006/07, you'll be able to take a pension pot of below £15,000 in cash. In addition, up to 25% of this amount will be available tax free. The Association of British Insurers reckons the average annuity purchase at the moment is not much more than £20,000, so this proposal will affect a lot of people.*

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 (TFC):

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) or even FSAVCs. Currently, you can't take AVCs or FSAVCs as a tax-free lump sum so it may be worth delaying taking these benefits until after A-Day if you're nearing retirement. Also, currently you can’t take any TFC from Protected rights pensions, (Serps, S2P) but this will also be changing from next year.

6) Pension income:

At the moment, when most people retire, they buy an annuity (income for life) and you have to buy an annuity with your pension pot by age 75:

After A-Day there is another option after age 75. You'll have the option of taking income using an Alternatively Secured Pension (ASP) 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. There will therefore be no compulsion to buy an annuity.
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.

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

7) What you can invest in:

The rules governing what you can invest your pension contributions into are greater with a SIPP than a personal pension. You can invest in nay of the following using a SIPP: TIPs, OEICs, UCITs, Unit Trusts, Traded Endowment, Hedge Funds, Direct Equities, Fixed Interest Securities, Warrants, Convertible Securities, Investment Trusts, Depositary interest, Commercial Property, Permanent Interest Bearing Stocks and other permitted investments.

Impact: In his pre-budget speech, Gordon Brown has made investing in residential property, fine wines, antiques and fine art unattractive, but there are a number of other allowable products that receive tax relief the same as a personal monthly contribution.

In conclusion:

Those 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. Not all the details of the changes have been finalised yet, but we do know most of the main points. The overriding thrust of the new legislation is to sweep together all the different rules we currently have for different types of pension scheme. The aim of the new pension legislation is to make pensions simpler. 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.

• *http://www.abi.org.uk/Members/circulars/viewAttachment.asp?EID=10627&DID=11135
• The information contained within this article does not make any recommendations or offer financial advice. You should seek Independent Financial Advice if you feel that any of the issues mentioned are relevant to your personal circumstances.
• The levels, bases and relief’s from taxation may be subject to future changes.
•  

As a consequence of the change in policy to the top up of your basic state pension, from SERPS to S2P, you may of recently received a letter from your current pension provider. This letter would of reminded you of your options to contract in or out, and asked whether or not you are happy with your current postion. In this article, I would like to briefly outline some of the issues at stake, so you can be better informed as to how they may effect you and consequently, decide what your best course of action may be.

First, what is the Second state pension scheme (S2P)?

Depending on your individual circumstances, you may be entitled to an additional State Pension. As its name suggests, the additional State Pension is paid in addition to the basic State Pension. Up to April 2002, the additional State Pension was called the State Earnings Related Pension Scheme (SERPS). SERPS was based on your record of National Insurance contributions and your level of earnings as an employee. (Note: the self employed however do not receive entitlement to SERPS.)

On 6th April 2002, the government introduced The Second State Pension which replaced SERPS to provide a more generous additional State Pension for low and moderate earners, and to extend access to include certain carers and people with long-term illness or disability. (Any SERPS entitlement already built up is protected both for those who have already retired and for those who have not yet reached State Pension age.)

And what exactly is Contracting out?

If you are an employed earner you can, if you wish, choose to leave the additional State Pension and join a private pension scheme instead. This is called 'contracting out'. If you do this, instead of paying lower National Insurance contributions, once a year HM Revenue & Customs will pay directly into your pension a rebate of your National Insurance contributions.

You can choose to contract out by joining your employer's contracted-out occupational pension scheme, which would mean when you retire, your contracted out benefit will be paid by the employers scheme provider and not from the goverment under S2P. You can also contract out with a stakeholder pension or a personal pension plan.

So, the big question, should you be contracted In or Out?

The answer to that question depends largely on your age, attitude to investment risk and your annual income. However, there is a fairly good argument based purely on a mathematical comparison of potential benefits, to stay conotracted in. This is because there is only a small chance of getting sufficient growth in your “own” plan to beat the “S2P promsie” by contracting out.

A 2005 repot by OAC indicated that investors aged 35 and under, who contracted out between 1988 and 1992, are the only group likely to have made any material gain as a result of their decision to contract out. All the other investors showed a potential financial loss, with the older the age at the time of contracting out the greater the likely loss.


However, I belive that this report failed to take into account three importnant considerations:

1. That dispite being able to actively choose, review and change where your rebate of NI contributions is placed, and while at the same time, having a greater choice of investment options to choose from, you do not out perform the government current promise of a relatively low, but none the less guaranteed return.

2. That the current government policy and legislation remains consistant and intact as it is now, and that the “S2P promise” stays in place until you retire, which may be decades into the future and at the mercy of numerious sucessive government policy.

3. That there are essentially three levels of NI rebate, the new S2P shceme rewarding medium and low income earners above the old SERPS sytem, whilst earners above the upper earnings limit actually being worse off under the new system.

My concluions to this are that it is very difficult to make any real definitive recommendation, but for those people that have a more adventuerious attitude to risk, are earning more than the upper earnings limit (circa £30,000) and are youger than 35, contracting out may still prove to be a good option. However, as every case is different, I would recommend that if you are considering reviewing your S2P pension status, that you contact your Wealth Matters adviser so they can more clearly identify the right course of aciton for you.

This article has been written with our understanding of the current legislation in respect of the Second State Pension. This article should not be deemed to constitute any recommendation or offer of advice as to whether to contract out is suitable, as this should be considered purely on an individual bases.

Further details can be obtianed from:

The Association of British insurers 020 7600 3333

The Pension Service 0845 7313233

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Many of the With Profits funds that we analyse for our clients have performed poorly in the last few years. Julian Gilbert looks at With Profits funds and discussed whether there is any life left in them.

For decades UK investors have invested large chunks of their savings plans, endowments and pension in With Profits funds. Many of these have done very well for their customers, producing bigger returns than initially projected. Over one million investors still have With Profits funds, worth ten of billions of pounds (1). However their performance has often been poor or abysmal in the last few years, with some funds having paid 0% in annual bonus payments for 3 years running. For some clients there are potentially better alternatives.

A report commissioned by Investment, Life and Pension Moneyfacts said that in July 2002, the average 65 year old who had contributed to a with profits pension scheme for 20 years would have been left with a pot worth £98,450. However, if the same man retired today after making exactly the same payments into his with profits plan the total value would be only £61,578, and this in spite of the recent upturn in equities. This represents a 38% fall in value. (2) (Bonuses are, of course, not guaranteed)

With Profits used to be considered as low risk because they invested in four main assets of equities, bonds, cash and property which meant that risk was diversified using a diverse asset allocation approach. The idea was to smooth the returns each year by paying out more in bonuses when the underlying assets under perform and paying out less when they outperform. Yet the product is not transparent, with investors and even advisers unable to ascertain what the life company is doing. They tend to be managed by in-house fund managers and actuaries, whose performance cannot be monitored easily by observers. The costs are unclear. Providers would ask their clients to trust them, although they would then be trapped with an investment for up to 25 years without a real understanding of how much of their monthly contributions were being absorbed by fund management and marketing costs. They can effectively dictate their own bonus rates, often without any obvious rationale.

In the 80’s and 90’s With Profits funds increasingly invested in equities, but during the fall in equities at the turn of the century, many providers were paying out unsustainably large bonuses. The first sign of problems ahead, was at Equitable Life. Tumbling bond yields undermined the guarantees it gave to some investors. After losing its legal battle to escape these guarantees, it was forced to adopt a highly conservative investment policy, reducing returns for investors, and at the same time, slashing the value of each investor’s fund. A Market Value Adjuster (MVA) was also used and is still used by life offices when the underlying assets are worth less than the value of the funds.

Then there are the requirements of the FSA. In order to preserve reserves in With Profits funds, many providers were forced to switch from equities into bonds close to the bottom of the worst bear market since the 1970’s. Therefore losses were crystallised, and the old adage of “buy low, sell high” was reversed. Other life companies, have left their clients high and dry. The Life company AMP fled the UK and returned to Australia. It’s UK companies, NPI, AMP and London Life moved their With Profits funds into bonds, and built in huge exit penalties if clients wished to leave – not a professional way to treat it’s clients!

So, what should you do if you have a With Profits fund? The best solution is to seek advice. Some funds, such as Prudential’s are quite respectable. Some Norwich Union With Profits funds are reasonable, yet others have produced no bonus for three years running. Below is a list of With Profits fund providers, where we would strongly recommend having the fund reviewed:

• Equitable Life
• NPI
• Pearl
• Royal Sun Alliance
• Scottish Mutual
• Hearts of Oak
• Brittanic
• London Life
• Scottish Provident
• MGM Assurance

1. Gartmore Seminar 11/11/05
2. Financial Adviser 13/10/05

“The value of an investment can go down. Past performance is not a guide to future performance.”

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