Act now to beat these pension changes
Age 50 and wanting to retire? Act now
A big change affecting people approaching retirement is the government's move to raise the minimum retirement age from 50 to 55 from April 2010 for everyone except those who are already drawing their pension.
People who will reach 50 before 6 April 2010 may be keen to take their pension before the opportunity is closed down. Of these, some may want to use this window to keep their options open but will continue working.
They may, for example, have always planned to retire at some point between 50 and 55. Others may see it solely as a chance to get their hands on their tax-free lump sum. The cash in your pension could be put to good use to pay off short-term debt, for example.
Most pension scheme rules have been updated to accommodate this change, but if your scheme rules still don't allow it then you might have to transfer to an income drawdown plan.
If this is the case, check you are allowed to rejoin the pension after drawing benefits or you may lose future contributions from your employer.
If you will be 50 by 6 April and are planning to start drawing benefits from your pension before the deadline, you need to ensure your pension funds have been received by the annuity or drawdown scheme provider prior to 6 April.
You will then be able to receive your tax-free cash lump sum after 6 April or up to 12 months after the start date of your retirement income arrangement. The key thing is to start the ball rolling now, as pension administration takes forever to sort out.
Laith Khalaf, pensions analyst at Hargreaves Lansdown, says: "Anyone planning to access their pension before age 55 needs to take action now.
"Investors with particularly tardy pension providers may find that they are already pushed for time, waiting any longer could well mean they miss the boat. Five years is a long time to spend regretting you didn’t complete a form just a couple of weeks sooner."
You may still be able to retire before age 55 after April 2010 if an earlier 'normal retirement age' is explicitly written into your contract of employment.
Otherwise, the only exceptions are high-octane occupations such as professional footballers.
Anyone who is incapacitated due to ill health may take pension benefits at any age, but the definition is based on being incapable of working in that occupation, and ceasing to work in that occupation, not just that particular job.
Seeking to reduce inheritance tax? Transfer your pension benefits to a flexible trust
The government used the December 2009 pre-budget report to cancel a planned rise in the inheritance tax (IHT) threshold to £350,000, and froze the tax-free limit to £325,000 per person to improve the UK's dire public finances.
It also closed inheritance tax loopholes involving the transfer of property into a trust. However, you are still allowed to put your pension in trust for your beneficiaries to stop that sum subsequently falling into your partner's estate if you die.
There will be a section in your application form that allows you to nominate the beneficiary.
Instead of automatically electing your partner/spouse, you can put the benefits in a flexible trust form to prevent your partner's estate being increased by the value of the fund. This may be in addition to any life insurance benefits payable on your death.
To do this, you will need to request the pension provider's normal flexible trust form. This will split the beneficiaries into the default beneficiaries, which is normally the children, and the potential beneficiaries, which is normally your partner, who will still have access to the capital and can draw on it when required.
Your partner's access may be in the form of a loan, repayable on death, which has the effect of reducing his or her residual estate for IHT purposes. Once you die, if your partner is sure the capital will not be needed then the trustees could, if requested, distribute it to the children.
Unlike a potentially exempt transfer, there is no liability to inheritance tax if your partner then fails to live for another seven years.
"The trustees of government-approved pension schemes are not normally subject to inheritance tax charges," says Mark McLaughlin, managing editor of tax information website taxationweb.co.uk. "This treatment compares favourably to the trustees of private discretionary trusts who can be liable to IHT when funds are paid out to beneficiaries."
In addition, if scheme trustees pay out funds within two years of the member's death, HMRC allows the funds to be distributed free of IHT by concession. McLaughlin says this is useful as it can allow benefits to pass to family members without an IHT charge.
"Of course, the payments will swell the recipient's estate for IHT purposes, but this problem can be avoided if the benefits are paid to a private discretionary trust," he adds.
The trust would be liable to potential IHT charges every 10 years or when capital is paid out, but the maximum IHT charge for discretionary trusts is only 6% and is often less, which compares favourably with the 20% IHT rate for chargeable lifetime gifts by individuals or the 40% charge on death.
High earner? Beware the maze of new traps
While 2011 may seem a way off, tax breaks on pensions will be squeezed like never before - so it pays to take advantage of the remaining loopholes.
A key change from April 2011 is that, for the first time, individuals whose gross income is more than £150,000 a year will be taxed on the value of their employers' pension contributions.
Tax relief on an employee's own pension contributions will be reduced on a sliding scale, dropping from a 50% rate at £150,000 to the basic rate of 20% at £180,000 a year or more.
On top of that, high earners will have to pay as much as 30% tax on the value of pension contributions made by their employer.
Taxing employers' pension contributions as a benefit-in-kind is a dramatic change in pension policy but it was inevitable, as the new 50% top rate of income tax means high earners would automatically receive that rate of tax relief on their own pension contributions, saving 50p in every pound.
To avoid higher earners making larger contributions to secure a higher rate of relief before the rules come into action, the chancellor introduced anti-forestalling rules that took effect from 22 April 2009.
The aim was to prevent high earners from changing their normal pattern of pension contributions to take advantage of higher rates of relief.
Effectively, from 9 December last year, anyone earning more than £130,000 who changes their regular contributions will fall within the rules in the same way as those earning more than £150,000 were previously affected.
High earners must be careful that they are not caught out by the anti-avoidance rule aimed at those trying to artificially reduce their income to less than £130,000, as they will potentially face a 20% tax penalty.
In ill health? Boost your income and leave less for the tax man
While the average life expectancy is increasing, many people reach retirement already suffering poor health. In terms of pension planning, ill health is a double whammy because the earlier you die the less time you have to draw your pension benefits.
Impaired life annuities, which pay a higher income for the rest of your life than a conventional 'healthy lives' annuity, are available for those in poor health, and income drawdown plans help because you retain control over the fund and can take a higher income from that than through a conventional lifetime annuity.
But both these types of plans are restricted regarding the maximum that can be taken from the fund because they are based on standard tables set by the government actuary's department (GAD) to guard against the fund being depleted too quickly.
Fortunately, there is a third option: the 'scheme pension', a bespoke solution particularly suitable for those suffering poor health because the level of income is calculated by an actuary taking into account the individual's health, age and fund value rather than being restricted by the standard rates issued by the government.
The scheme pension actuary's role is to ensure the pension is not exhausted before the policyholder dies, so a much higher level of income can be taken for people in poor health.
The actuary will also manage down a scheme pension fund to leave as little in the fund on death as possible, in effect reducing what's left for the taxman.
For example, a 65-year-old man with a £500,000 fund who is in poor health would be able to take a maximum of around £43,800 a year under an ordinary income drawdown arrangement based on the standard GAD rate, which is exactly the same as someone in good health.
Under the scheme pension, the actuary will take into account the individual's health and an income of more than £53,600 could be taken if, for example, the actuary calculates that the pensioner is likely to live for another 14.7 years.
For older people, the attractions of a scheme pension over conventional pension plans is even greater.
Another attractive feature of a scheme pension is that it may be written with a 10-year payment guarantee, so a 75-year-old pensioner with a 10-year guarantee will, with a 10% drawdown rate, be assured that the full benefit from the pension fund will end up either with the pensioner or the family over the next decade.
Scheme pensions are offered by Hornbuckle Mitchell, Rowanmoor Pensions, AXA Winterthur, Talbot & Muir and TM Sipp Services.
Money for nothing: a simple tax wheeze for those of retirement age
Provided you're under 75, you can benefit from tax relief on pension contributions by paying into a stakeholder pension whether or not you've already retired and whether or not you're earning anything.
You are allowed to contribute 100% of your earnings (up to £245,000 for the 2009-2010 tax year) or up to £3,600 a year if you are not working. This allows parents, for instance, to take out stakeholder pension plans for their children.
Stakeholder plans can be used simply as a means to get something from the taxman for nothing.
If, for example, you're not earning and you pay the maximum £2,880, after tax relief, into a stakeholder pension, the pension provider will then claim back basic-rate tax relief of £720 from the government, thereby giving a total contribution of £3,600.
If you're already of retirement age, you can immediately take a quarter of the fund as tax-free cash and buy an annuity with the remainder to provide a taxable income for life. In this way, you make 20% on your savings straightaway.
But you have to tie up the rest of the money in an annuity that pays out an income for life.
"While the initial tax benefit sounds attractive, swapping cash in the bank for a lifelong taxable income is inflexible and may ultimately leave you out of pocket depending on how long you live," says Justin Modray, director of candidmoney.com. "Annuity rates are also low, further diminishing the potential appeal of this tax wheeze for many."
Extending the non-earner example, taking £900 of tax-free cash from a £3,600 pension fund would leave £2,700 to buy an annuity, which has effectively cost you £1,980.
If the resulting post-tax annuity income looks worthwhile, and you think you'll live long enough to profit, then this route might hold some appeal, says Modray. But for many the potential risk and hassle makes immediate vesting annuities a non-starter.
Such strategies are particularly attractive for people who are high-rate taxpayers but are about to enter retirement as basic-rate taxpayers.
Making a large contribution, say £6,000, in their final year of work would benefit from higher-rate tax relief at 40%, in this case effectively £10,000.
After retirement they can take £2,500 as a cash sum, which actually cost £1,500, leaving £7,500 to buy an annuity (which before relief actually cost £4,500).
"If they'll be a basic-rate taxpayer during retirement then the benefits are more compelling," adds Modray.
This article was originally published in Money Observer - Moneywise's sister publication - in February 2010
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
A form of money purchase defined contribution pension launched by the then Labour government in April 2001 with low charges and no-frills minimum standards. Designed to appeal to people on low and middle incomes who wanted to save for retirement but for whom existing pension arrangements were either too expensive or unsuitable, the stakeholder didn’t really take off and looks to be superceded by the National Employee Savings Trust (NEST).
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.