The new A-Day regime, which comes into force on April 6, aims to simplify UK pensions and widen the choice of investments that individuals can hold in their self-invested personal pensions (Sipps). The shake-up will enable high earners to channel larger amounts of money into pensions schemes and give them more flexibility over how they can take benefits.
Ian Price, head of pensions at St James’s Place, the wealth manager, and Tom McPhail, head of pensions at Hargreaves Lansdown, the financial advisers, answer your questions on how A-Day will affect the pensions industry and how you should be planning for the future.
The Financial Times is publishing a comprehensive guide to Sipps and A-Day on Saturday April 22. This will be distributed free with the newspaper on this date.
I am planning to transfer my private pension which includes my protected rights into my local government pension to increase my years of service. Would the new A-Day pension measures put me at a disadvantage should I decide to transfer?
Janice Durant, Kingston upon Thames
Ian Price: When you transfer to the local government scheme your future benefits will be guaranteed. Whether this is advantageous will to a certain extent depend upon your future salary increases.
You should remember the way in which you will be able to take benefits from the scheme is fixed i.e. you will have to take benefits in the way the scheme pays them rather than being able to choose a pattern of income that might more closely fit your needs.
A-day does not appear to affect this decision based on what you have told us.
Tom McPhail: The A-Day rules themselves will not make a significant difference to your plans. There are just a couple of points which might be worth noting.
The new rules allow greater flexibility in the management of your retirement provision, but some schemes will still be more flexible than others, in terms of how and when you take your benefits. In making the transfer, you may be giving up some flexibility. Also, your tax free lump sum rights may be calculated in a different way under the rules of the local government scheme; from A-Day you would be able to take 25 per cent of the current protected rights fund tax free.
It’s not necessarily a bad idea to go ahead with the transfer, but you should consider these points.
What would be the main advantages and or disadvantages of moving money from either deposit accounts or other saving schemes ISAs etc into a pension scheme? It would appear that as a higher rate ask payer, this would be a way to generate a 40 per cent benefit overnight in long term savings. Would the restrictions in accessing these monies through annuity rules and age be offset if you were older, or planning early retirement?
John R Turner
Tom McPhail: Research shows that for most people in most circumstances, pensions are the most tax efficient way to save for retirement; especially if you are a higher rate tax payer.
The loss of flexibility and control over the money if you pay it into a pension is a consideration, to which there isn’t a universal answer. Make sure that you have sufficient savings outside the pension to meet your short and medium term needs.
The tax treatment of savings in ISAs and pensions is the same, while the money is actually invested, so the length of time until retirement isn’t an issue when comparing these two types of investment. With cash which is not currently in an ISA, the longer to go until retirement, the stronger the argument for investing it in a pension. This is because it will have more time to benefit from the tax-free growth which pension funds enjoy.
Ian Price: A-Day rules will normally allow you to put more money into your Pensions. As you quite rightly say it will be possible to move money from existing saving vehicles into your Pension.
The contribution will be increased by basic rate tax. Any higher rate tax will be reclaimed by self assessments or PAYE code. The disadvantages will be that the assets are now subject to Pension rules.
I work for two separate Ltd companies totally unrelated each pay £35,000 per year. After April 6 could I pay one of the £35,000 salaries direct into my Sipp and if so would this be paid gross?
Tom McPhail: In principle, yes you could. If the payment is made by the company then it will be treated as a gross contribution. If you pay the money in yourself from after tax income then it will be treated as being net of basic rate relief. Again, in principle you would be able to claim higher rate relief through your tax return.
Ian Price: In your case it will be possible to pay up to £70,000 per annum. However any contribution you pay will be net of basic rate tax.
I am one of three controlling director of a private limited company. We currently have executive pension plans in place with Standard Life and Scottish Equitable (pre-1987 rules). My two colleagues draw a small salary of £8,000 p.a. each and take the rest of their remuneration as dividends. I do not currently take any salary and have waived my right to dividends for the current financial year which ends on 31.12.2006. I take a salary of £36,000 p.a. from a sister company which has the same directorship as the main company. My colleagues do not take any remuneration from the sister company.
The main company will shortly receive approximately £300,000 from the sale of office premises that we have ceased to occupy. We intend to pay the proceeds as an employer’s single contribution into either one or both existing EPPs or new Sipps. I understand that there is no limit on the amount an employer can pay in pension contributions, but that the maximum for corporation tax relief is £215,000 per individual. I have heard that the Inland Revenue may not look favourably on cases where large pension contributions are paid in conjunction with what might appear to be artificially low salaries. Given our circumstances, is it likely that payment of a single contribution of £100,000 for each of us could result in a tax charge as a benefit in kind? What is my position given that I receive no remuneration from the main company that will be paying the contribution?
Bernard Witty, North Yorkshire
Ian Price: Your situation is really interesting and relates to one area where we believe the rules are less certain, that is, tax relief on Pension contributions by employers. The tax relief will be dependent on whether or not the Local Inspector of taxes accepts that the contributions are “wholly and exclusively for business purposes”.
If the company was to pay £100,000 it would not be treated as a benefit in kind to the Directors.
Based on the information provided it is unlikely that full tax relief will be granted. We suggest that you talk to your accountant before making any contribution.
Tom McPhail: In principle, a company contribution of £100,000 for each of you shouldn’t trigger a personal tax liability. Whether the contribution is deemed excessive is a question which needs to be addressed to your local tax inspector - and given your circumstances it certainly should be.
There is also the question of who is going to take responsibility for being the scheme administrator for these schemes after A-Day. You might want to discuss this with your adviser or the insurance companies.
Whilst it is all good to give individuals greater freedom in making their retirement investment decisions, there are some questions that have been nagging me:
(1) What is the information set available to the individuals to make those decisions?
(2) Are there information asymmetries, even across high income earners, that some individuals will be able to better exploit than others, and this in turn could imply some individuals taking decisions on an incomplete information set?
(3) What are the risks of moral hazard-adverse selection?
(4) Would this new rule increase the need for greater supervision (and associated costs) to ensure that the money of individuals would be well managed?
(5) On a more theoretical note, what is the flexibility of the new system as regard the uncertainty associated with future income?
Vimal Thakoor, Edgbaston
Tom McPhail: Yes there are lots of asymmetries, and uncertainties, and there will be winners and losers. The regulatory framework has to be proportionate; even the best system will contain injustices. There is a clear political agenda of personal responsibility though, so within the current framework, it is generally true that the better informed one is, the more one is likely to get out of the pension system.
Ian Price: When looking at all the new investment opportunities it is clear individuals will need advice to help them make their investment decisions.
Your chosen investment vehicle will determine the amount of information that you will receive e.g. for a unit trust you will receive more information than in if you decide to invest in Futures and Options.
In order to answer your question on supervision it is important that you select the right advisor to help you.
Does the maximum annual amount you can put into your pension depend on your income in the year that you invest or the income in the previous year?
Tom McPhail: From A-Day, contribution limits will be based on current year earnings.
I am a higher rate taxpayer aged 42 and I am thinking of using my current SIPP as a tax efficient vehicle for investing for both retirement and funding school fees. I currently have no mortgage and a property worth more that £600,000.
The basic idea is to take my current cash and ISA investments and move these into my SIPP in order to get the maximum possible of the 40 per cent tax relief, these funds will be invested and begin to compound within the SIPP. I plan to fund school fees out of income for several years until I approach age 50, I may then need to begin to borrow against my property asset in order to continue funding the school fees. The at age 55 I could choose to take a tax free lump sum from my SIPP in order to repay the borrowings and assuming that I’m still working and still a higher rate tax payer, I could even use any remaining cash from the lump sum to re-invest in my pension and get the tax relief again. This all sounds too good to be true, is it?
What are the risks of linking school fee planning to retirement planning? Could a future government remove the ability to take the tax free lump sum?
What are the chances that they might do this? If I decide to take the tax free lump sum at age 55, but want to delay retirement until age 60, would this be a problem? What happens to the money in the SIPP in the event of my death, assuming that this happens before any annuity has been purchased?
Colin Rhodes, Leicestershire
Ian Price: The way in which you are considering funding school fees can work As always it is important to take advice to make sure that this is appropriate in your circumstances.
It will be possible to take Tax Free Cash at 55 even if you are still working and defer taking an income until you stop working.
The Government has introduced new rules that will effectively stop you from recycling your lump sum into Pensions.
There is always a risk that any future Government may change the tax rules on any investments however there is no indication of this at present.
The position on death is complicated and will depend upon the following
1, Whether you have started to take your benefits
2, How you are taking benefits
3, The age at which you die.
Tom McPhail: There’s a lot to take into account, so you should take the time to go through the plan in detail with an adviser. You may be better served by using the ISAs for the school fees planning, and keeping the pension to provide a retirement income. If you start drawing on your pension in your early fifties, then it may have to last a long time. The new A-Day rules do give you a lot more flexibility, both over paying money into a pension, and drawing it out. I suggest that you look at them in detail to make sure you are using them to best effect.
I have an AVC which I started after 1987 which under the new rules would allow me to take 25 per cent of the fund. However I took early retirement from Norwich Union at 50 in 2002 from the main scheme but did not touch the AVC. The company are currently examining as to whether I am entitled to the 25 per cent. Their reasoning is that as I took early retirement this may crystallise the scheme and I am therefore bound by the rules prior to A Day. They have not yet come back with a decision, could you please give me your opinion.
Tom McPhail: My opinion is that you should now be allowed to take the tax free cash, but I would want to check it with the Revenue before offering a definitive answer.
Ian Price: Although the legislation allows you to take tax free cash from uncrystallised schemes, the rules of your scheme may not allow this. If this is the case then you could ask the trustees if they are willing to change the scheme rules.
I have a question for Tom and Ian about my pension arrangements following the decision to change the earliest retirement date to 55 from 2010. I am 42 years old, have been in generous final salary schemes since I was 19 and have been making additional savings for the past 17 years specifically to take advantage of the early retirement options of my employment contract. However, because of the small print of the Finance Act 2004 my employer has been forced to withdraw its early retirement option for which I have been saving so hard for many years. The cost will be the loss of an indexed linked pension of £20,000 p.a. in today’s money plus the right to draw a tax free lump sum of £100,000 at age 50.
Whilst I respect the right of the Government to set the rules for benefiting from tax free savings, what right do they have to cause a breach of my employment contract and create AVC mis-selling on a grand scale. Do I have grounds for compensation for my loss of money and freedom?
Ian Price: Unfortunately, with many changes in legislation there will be people that lose out. Regrettably it would appear that you are caught by the changes in minimum retirement ages.
There is no course of redress in these circumstances.
Tom McPhail: Not surprisingly, the answer is no. It was a tough choice for the Government to make some of the rules retrospective, and to disappoint some investors. I believe that your only realistic option is to negotiate with your employer over the terms of your scheme.
I have delayed my retirement for a year in order to take advantage of the new rules. Now that it has arrived my professional adviser says the Treasury have still not published details of the legal admin procedures to be followed in calculating and paying out pensions and that as the lawyer wishes to be exact I must suffer a further delay till they are available.
Considering how long A-Day has been in the making it hardly seems possible there should be a delay. How long will it be?
Tom McPhail: I’m not sure which specific aspect of the rules is causing the delay, so I can’t give you a complete answer, but if past experience of dealing with HMRC is anything to go by, don’t be surprised if it takes a few months.
Ian Price: Unfortunately we are unable to tell which particular aspect of legislation your lawyer believes to be missing and thus unable to confirm when it will be finalised.
How do the A-Day Reforms alter the trade-off in pension investment between on the one hand, enjoying a tax efficient wrapper for savings between now and retirement, and on the other, needing to live too a ripe old age to get value from the commitment required to buy an annuity?
Assume your investor is in his early 50s and is proposing to down-shift soon as his children leave the family payroll and has surplus funds to invest from past and current employment income being taxed at 40 per cent
Ian Price: The great news is we are all living a lot longer and that life expectancy is increasing very quickly.
There has always been a lot of discussion around annuities, but they are still a very good option as they guarantee a level income until you die, whatever age that might be.
Obviously the ‘A’ day changes have increased the options at retirement and, depending on your circumstances and attitude to risk, you may want to consider an unsecured pension (drawdown).
Tom McPhail: Contrary to widespread opinion to the contrary, annuities are reasonably good value for money. Having said that, your early fifties is perhaps premature to lock into an annuity. A Drawdown arrangement might be worth looking at, if you are comfortable with the additional risks involved.
With A-day liberalising pensions for many, including allowing a relatively greater degree of flexibility in terms of the individual’s choice of investments, what would you argue a young investor starting out with their first pension should be looking for? Although my company doesn’t offer their own in-house scheme, they contribute. I am facing the dilemma of choosing between a SIPP and a stakeholder pension but I’m not clear on which offer greatest value.
Ian Price: The good news is you are starting to consider funding a pension at a young age. The earlier you start funding a pension the larger it will be when you retire.
When looking at the different options you have available you need to consider what your investment strategy is going to be and also the level of contribution you are willing to make.
For example, within a SIPP you will need to make your own investment decisions, is this something you want to do?
If not, then funding a stakeholder and investing in (say) a managed fund will mean that these decisions are made for you.
In order to help with this decision-making, it would be appropriate to take advice.
Tom McPhail: Stakeholders are great if you don’t know what you are doing, Sipps are great if you do. In terms of charges, there is little to choose between a stakeholder and one of the low-cost Sipps which have developed in the last few years.
The younger you are, the more risks you should be taking, so in your twenties and thirties you should have the bulk of your money, if not all of it, invested in equities.
I currently have two defined benefit pensions from different employers. I am currently receiving a pension from one (I did not take any cash when the pension payment started), and am still contributing to the other one with my current employer. I also have a private pension from which I have not yet elected to take any benefits. Given that taking cash from a defined benefits scheme is poor value, will I be allowed to pool the value of all three schemes and take all of the cash from the private scheme? (up to 25 per cent of the combined value.)
Ian Price: In the vast majority of cases it is not possible to pull the Tax Free Cash across different Pension schemes.
The only exceptions would be if you registered for Primary Protection or if you transfer all your schemes into one (for which your should seek advice).
I have two questions:
1) I (or better to say my company which I wholly own) have a SSAS which has me as the sole member. I am not planning to fully retire while my health permits and work until the end. Over time I am going to reduce my hours rather than shut down. What is the best way of taking out some of the pension at some stage, say age 60 or late fifties onwards while working.
2) Assuming there is much money left in this fund, I need to consider succession. My daughters also are company employees but not currently members of the pension fund. Is there a suitable tax efficient way of passing the leftovers of the fund to them, other than as part of my estate, once I part this world? Critically one does not know what these leftovers will be in advance. I have no problem selling them some of the company shares.
Hamid Anvari, London
Ian Price: It is possible to phase your benefits to meet your changing work patterns . However which way is ‘best’ will depend on your circumstances at the time and you should seek advice.
If your daughters were part of the Pension schemes it would be possible to allocate money to them before or after your death.
The way in which you pass money to your daughters will depend upon
1, Whether you pass the money before or after you take benefits
2, How you are taking benefits
3, Your age at death
I plan to retire early around the end of April 2006 at 52 years of age and have a pension fund of £400,000 in round figures.
I am relatively risk averse and after taking the 25 per cent lump sum, my thoughts are a level annuity for the £300,000 balance. This provides the income I require at the front-end with future inflation being supported through equity release on property around the age of 60.
The criteria I have used for this decision are:
• 25 per cent deduction for cash lump sum
• Joint life
• Level annuity with 10 year guarantee
• Male age 52 non-smoker
• Spouse age 55 with 50 per cent pension
This will provide an annual income of circa £15,640 - Is there a better solution?
A Pringle, Scotland
Ian Price: The key is your statement that you are risk averse. This seems to lead you to buying an annuity.
When looking at which annuity to buy you should consider using the open market option to get the best annuity available at the time.
The FSA provide competitive tables on their website (fsa.gov.uk) that will give you an indication of the best rates.