Pensions

So what’s new in pensions?

It is possible to contribute up to 100% of your earned income each year, with tax relief given to the extent that you have paid tax on earned income, subject to an annual limit of £255,000 in 2010-2011.

Rules were announced in the April 2009 Budget which apply in respect of tax relief on contributions to anyone earning £150,000+. You can also contribute to as many different pension schemes as you like, so you can contribute to a personal pension, as well as a company scheme at the same time.

Remember that there is flexibility as to how, and when, you can take your pension when you retire, including a range of flexible annuities.

Can I get tax relief?

Why would anyone want to invest in a pension after so much bad publicity in recent years? Well, the answer is quite simply tax relief.

Contributions to all types of pension scheme automatically attract basic rate tax relief at 20%. This means you only have to write a cheque for £800 to make a gross contribution of £1,000, as the taxman tops up your pension with £200.

Even non-taxpayers can contribute up to £2,880 net (£3,600 gross each year) into a stakeholder pension and benefit from the same basic rate tax relief. For a higher rate taxpayer, a £1,000 contribution costs only £800 upfront, and a further £200 tax relief can be claimed via one’s self assessment tax return, bringing the net cost down to £600.

With company-sponsored final salary schemes, tax relief is claimed by your employer. If you invest in a group personal pension, your contributions will be paid net of basic rate tax, but if you are a higher rate taxpayer, you have to reclaim the extra 20% tax relief via your tax return. This is unless you contribute via a salary sacrifice scheme, in which case you have already effectively had tax relief, because your contributions are made directly out of gross salary by your employer to your pension provider.

In tax year 2010-11, higher rate tax relief for pension purposes kicks in at £43,875+.

Personal and employer pension contributions

The maximum annual contribution is 100% of your earned income up to a maximum of £255,000 in tax year 2010-11 (but different rules apply for those earning £150,000+).

The lifetime allowance, the maximum pension fund size you can have while enjoying tax privileges, is £1.8m in 2010-11. This limit will remain at the same level for at least five years.

Your employer can make very large contributions into your personal pension, provided that the total of all employer and your personal contributions does not exceed the annual contribution limit of £255,000 (2010-11).

What are the permitted investments?

• It is now possible to invest in a very wide range of investments via a self invested personal pension or SIPP including:

Stocks and shares listed or dealt on an HMRC-recognised stock exchange, including AIM

Stock exchanges that are not recognised by HMRC, such as Ofex

Unit trusts, open ended investment companies (OEICs)

Warrants and covered warrants

Government stock and fixed interest stock

Unquoted shares

Permanent interest bearing shares (PIBs)

Commercial property

Hedge funds

Private equity

Collective property funds.

This is not a comprehensive list but gives an indication of the wide investment freedom you now have.

You cannot invest in residential property or 'prohibited investments' such as vintage cars, works of art or fine wines within a SIPP, as was originally proposed. If you do invest in these assets an extra charge of up to 70% of the value of the prohibited investment will be applied.

This means that although it is possible to invest in residential property and exotic investments, the additional tax charge makes this an unattractive option.

Annuities and drawdown - the options

There is been great choice and flexibility in the way you can take your retirement income. You can do income drawdown until age 75 via an unsecured pension, and after age 75, via an alternatively secured pension.

The rules governing final salary schemes have been relaxed so that you can draw a company pension while working for the same employer.

There also some new hybrid products, which are a mixture of annuities and income drawdown.

What are trivial funds?

If you have a very small pension fund/s – less than £18,500 (in 2010-11) – the new rules allow you to take the entire fund as cash.

A quarter of these sums can be taken tax free, with the balance being taxable.

You must take into account all your pension funds, including the value of any pensions you are already receiving, when assessing whether your total funds fall within the £18,000 limit. You must also take all such trivial funds within a 12-month period. There is also an additional trivial pension limit for occupational pension schemes of £2,000.

Income drawdown

You can defer annuity purchase when you retire, by keeping your pension fund invested in an unsecured pension. This allows you to take up to 25% of the fund tax free and an income each year, if you so wish, although there is no obligation to take any income at all in subsequent years.

The maximum income you can take through income drawdown is roughly 120% of what a single life annuity, (as calculated by the Government Actuaries Department (GAD), would pay for someone of your age. There is no minimum income as there is no obligation to take an income. In fact, you can take zero income and leave your entire fund invested until age 75.

To make sure that your income limits are linked to current annuity rates, your unsecured pension must be formally reviewed every five years.

If you die before age 75 while taking an unsecured income, there are three options:

• The remaining fund can be paid to your dependants less 35% tax
• A spouse could continue taking an unsecured income
• The fund can be converted into an annuity.

Alternative secured pension

When you reach age 75, you are allowed to continue taking a restricted form of income drawdown for the rest of your life, called an alternatively secured pension or (ASP).

The ASP allows you to draw a maximum income, which is roughly equivalent to 90% of a single life annuity for someone aged 75.

The minimum income you can take is 55% of a standard annuity for a 75-year old. These income limits remain tied to annuity rates for a 75-year old, so your income will not rise as you grow older.

It is not possible to transfer funds to family members if there are no dependants, without paying a large amount of tax. Any such payments will be treated as an ‘unauthorised payment’ and taxed at up to 82%.

Alternatively, the fund can be used to pay a pension (but not a cash lump sum) to a spouse or civil registered partner.

If you have no dependants, you can donate the remainder of your fund to charity, free of tax.

The importance of retirement planning

What do most people do when they come to retire? The vast majority of people still buy annuities because they are the only instrument that will guarantee an income in retirement and to take unsecured pension you need a fund of at least £200,000 or other assets to live off.

Drawdown may seem attractive, but many people grossly underestimate the risks and are attracted to the death benefits, when they should really be concentrating on maximising their income.

To be cost effective, you need a pension fund of at least £200,000 to do income drawdown (unless you have other assets to live off, in addition to your pension fund).

You do not have to put all of your eggs in one basket and you could consider purchasing more than one type of annuity, for example, a level or increasing annuity and a with-profits or unit linked annuity.

The latter will pay an income that will increase or decrease in future years, depending on investment returns.

Used wisely, the greater flexibility now available should enable you to plan for a better retirement and the pension that you deserve but to get the most from the new rules you will need specialist independent financial advice.

If you want to find out more about the features of a SIPP then try our SIPP Star Rating tool.