With just a year left before the introduction of pension tax simplification on April 6, 2006 (“A-Day”) it’s time to find the right adviser who can guide you through the minefield that lies ahead for the unwary and unprepared.
Your adviser will collate all of your current and previous pension arrangements and calculate their total monetary value. If you have deferred (“retained”) benefits from the scheme of a former employer, you or your adviser should get in touch with the trustees as soon as possible, as valuations can take several months.
Once completed, this exercise will help you to decide whether there is scope for additional funding before A-Day, and in particular enable you to discover whether you can increase your tax-free cash entitlement.
The new rules allow you to withdraw a maximum tax-free cash sum worth 25 per cent of the total fund. But you could find that you are better off under the current regime as, under some schemes, you can achieve more generous tax-free cash payouts. If this is the case, it is possible to register these superior entitlements to avoid losing them after A-Day.
A clear picture of your total pension value will also help you determine whether you should apply for ”protection” against the 55 per cent tax that will apply on funds in excess of the new ”lifetime allowance” of £1.5m (in 2006-2007).
A good adviser will have tax and pensions expertise in equal measure as well as access to high quality IT resources that will enable him or her to cover all the available options in a way that is specific to your circumstances.
Some major firms of advisers and consultants have devised their own simplification software; others will use the software supplied by a life office.
Your adviser should automatically take a financial planning approach, which places the priority on achieving your retirement objectives and not on maximising tax efficiency just for the sake of it.
“A retirement objective might be to be able to afford to retire at age 55 and climb mountains,” says Rob Noble-Warren, a certified financial planner (CFP) and director of Independence Financial Planning. “Paying more into a pension plan to maximise tax efficiency is not an objective in itself – although it’s a step you might take to help you achieve your personal objectives.”
Early retirement – a common goal for high-fliers – will be a significant factor in your decision-making, as this may reduce substantially the retirement income you can achieve.
Planning is often complicated by the fact that you may wish to keep your retirement plans private and may not therefore be in a position to have a frank discussion with your employer about the impact on benefits.
Under the new rules, the minimum retirement age will rise from 50 to 55 by the year 2010 but, in most cases, it will be possible to preserve your existing rights if this is part of a contractual arrangement.
In some cases your decisions may not appear to be tax-efficient or risk-free. For example, if you want the maximum amount of cash and you are some years off retirement, you may decide to pay the lifetime allowance charge of 55 per cent on funds in excess of the £1.5m fund limit.
If you are looking for greater investment control over your fund, you may decide to move from an apparently secure employer- run “final salary” scheme into a self-invested personal pension (Sipp), which allows you to invest in collective funds, equities and bonds, commercial property, and, after A-Day, also residential property.
Using a Sipp to move into income drawdown (”unsecured pension” in the new jargon) in retirement allows you to keep your fund fully invested and to draw an income directly out of your fund – but this does mean that you will have to continue to manage the investment risk. However, it also offers considerable scope for estate planning, as it is possible to pass on your remaining fund on death to your heirs, after a 35 per cent tax charge. From A-Day it will be possible to continue in a more restricted version of drawdown using the new Alternatively Secured Pension (ASP) rules.
“Before you make any decisions you need to know how your employer will deal with the impact of simplification,” says Julie Sebastianelli, a director of the private client services division at Deloitte.
“Most employers will be anxious not to increase overall costs but will need to change their benefits package for senior executives and directors – for example, they may replace an ‘unapproved’ scheme for high earners with cash.”
Owner-directors will re-quire specific advice, as their funding choices before A-Day may be very flexible but after A-Day they may be limited, she warns.
Noble Warren urges those with children to consider simplification planning in the context of family finances.
“Planning for retirement might usefully include creating a family safety net.
We are the fortunate generation. Our children can’t get into defined benefit pension schemes but carry the same expectations as ourselves. They may have a tough time achieving financial independence without help.”