Pensions – Your Flexible Friend?

With a continual stream of negativity surrounding pensions, and recent legislation only limiting what a government clearly sees as already generous tax-relief concessions, many pension holders would be forgiven for missing several positive changes that will allow those aged over 55 to gain more control and flexibility over when and how they use their retirement savings.

First is the removal of the ‘age 75’ rule that effectively obliged anyone with private pension savings to use them to buy an annuity by this date. This means that pensions can now be left invested for longer with little disadvantage. Even tax free cash which previously had to be taken or lost by age 75, can now be deferred.

Secondly, for those that meet certain eligibility criteria, plan holders can now take an unlimited lump sum from a drawdown pension arrangement, without the maximum income restrictions that apply to conventional drawdown arrangements. Income tax is payable at the member’s marginal rate of tax, so those interested in doing this may well wish to stagger withdrawals over several tax years. To be eligible for flexible drawdown, individuals must show that they already have ‘secure pension income’ of £20,000 or more, per annum. This could be made up of annuity, defined benefit pension and/or income from scheme pension. Income from a drawdown pension arrangement, as not guaranteed, cannot be used.

Flexible drawdown could, for example, be used to meet one-off large expenditure items as they arise or to optimise tax liabilities. It can be a way to pass money through the generations, either by ‘gifting’ regular payments, for example into trusts, or as pension contributions to children using ‘normal expenditure’ rules so as to help avoid inheritance tax. In moving money out of a pension fund before death, the pension holder will be paying income tax on such payments at a lower rate than the hefty 55% tax charge payable on a lump sum payment form the pension fund on death.

The increased tax charge on death to 55% on all crystallised pension benefits, or all benefits post 75 from drawdown pension, replaces the previous 35% before the age of 75 and up to 82% on death afterwards.

These changes were not widely publicised at the time, but provide huge planning opportunities for those with larger, flexible pension arrangements. Moving forward there is a strong argument, where available, for these individuals to strategically withdraw lump sums from their pension arrangements to reduce the ultimate tax charge on death.

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Don’t forget the kids!

Whilst many of us will be busy finalising contributions to ensure 2011/12 ISA limits are utilised, those with young children may wish to consider the recent change to child savings. Like the adult version, Junior ISAs allow tax free income and capital gains growth. The Investment limit is lower at £3,600, although this will rise in line with inflation from 2013. Junior ISAs replace the former Child Trust Fund (CTF), and those with existing CTF benefits are unable to hold both.

Junior ISAs are set up in the child’s name by a parent or guardian and available to each child in the family each tax year. Under the rules of Junior ISAs, the child is the beneficial owner of the funds which must be locked away until the child reaches the age of 18. At that time the funds can either be withdrawn or rolled over into the normal ISA version. Funds can be invested in Stocks and Shares, Cash or a combination of both.

Junior ISAs provide an excellent tax-friendly vehicle for family and friends to save for a child’s future, the funds potentially being used to assist further education or a house deposit for example. Over a potential 18 year investment period, a sizeable fund could be generated. For those looking to gift any excess income, such as grandparents, Junior ISAs can sit alongside children’s pensions to provide useful funds for different life events.

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What’s in store for pensions?

With the tax-payer already squeezed, experts are warning pension holders that they might be in line for some amending of pension rules in order to raise additional tax revenue come next month’s Budget.

Whilst the Lifetime Allowance will already reduce to £1.5million from its present £1.8million in April, the Exchequer may also look to trim the Annual Allowance limit, currently £50,000 per annum. A lower contribution limit, of say £30,000, would still provide significant scope to accumulate generous lifetime pension benefits. The ability to mop up unused allowance from the previous three years by way of carry forward and the ability of the scheme to then pay any arising charge, would largely alleviate the problem for those average paid employees in defined benefit schemes where a promotion or pay rise could potentially lead to a spike in that year’s contribution.

Another tax revenue raising area could be in the restriction of tax free cash available from pensions. A reduced maximum limit rather than the current maximum 25% of the Lifetime Allowance would leave a greater level of taxable pension income.

The removal of higher rate tax relief on pension contributions is an area favoured by the Liberal Democrat side of the coalition. This move would see the elimination of 40% and 50% tax relief with a flat basic rate of 20% offered. The Cabinet Minister, Danny Alexander claims that removing the higher-rate tax relief would save the Exchequer more than £7 billion and would make the system fairer. Even restricted to those earning more than £100,000 the Treasury could save £3.6 billion.

However, Ministers should act with caution. At a time when pensions are being hammered by volatile investment returns, reduced annuity rates and employers cutting back on contributions and benefits due to the economic climate, a quick fix to the public finances could see the long term pension problem – and an already ticking, retirement savings time bomb – further exacerbated. Making pensions less attractive to the decision makers of a company is only likely to lead to a greater apathy further down the workforce.

Even for many of those above average earners paying into retirement plans within the current pension structure, they are unlikely to accumulate sufficient funds to ensure a comfortable living in retirement.

It would be fair to say that pensions are unlikely to be made more generous and therefore those that can afford to should maximise the opportunities available to them sooner rather than later as any changes in the budget could make a significant difference to future retirement benefits.

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Higher Relief, Higher Risk

To help kick start the economy, along with changes to Enterprise Investment Schemes and Venture Capital Trusts, the new tax year will see a new type of investment offering generous levels of tax incentives. From April, the little brother of the established Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS), will be born. The aim of the SEIS is to stimulate entrepreneurship in UK companies by allowing individuals to invest in a company up to £100,000 in a single tax year rising to a maximum of £150,000 over two or more tax years. Investors will receive up to 50% tax relief in the tax year the investment is made, regardless of their marginal rate. The overall tax treatment depends on the individual circumstances of each client and may be subject to change in future.

Due to the generosity of the tax reliefs, there are even greater restrictions on a SEIS than an EIS. Investors cannot control the company receiving their capital, the investment must be in a UK company not employing more than 25 workers, and the company must be a start up business with assets of less than £200,000. In addition, the investment may well be, at times, illiquid. A further advantage is that in the 2012-13 tax year, tax payers can roll any chargeable gain in the tax year into a SEIS with a full capital gains tax exemption.

For those clients with the risk appetite, a SEIS investment offers an exciting opportunity to invest in a seed company at a very early stage. Where a SEIS is deemed appropriate within an overall portfolio, clients should ideally earmark a specific proportion of their funds that they are comfortable with allocating. These high risk tax products should be used, ideally, once other lower risk tax-favourable structures are used such as pensions and ISAs. SEISs are very high risk strategies and individuals should appreciate that the generous levels of tax relief are offered to offset the significant possibility that the client may not get back some or even any of the initial investment.

Matt Hawkins

Chartered Financial Planner

MillionPlus Financial Planning

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The Demise of Protected Rights

The Government has finally decided to make changes to Protected Rights by abolishing some forms of contracting out. This will aid and simplify the pensions system and offer important opportunities for pension holders. These significant changes come into effect from the new tax year in April for pensions built up on a defined contribution basis such as stakeholder or personal pension arrangements.

Protected Rights are the benefits accrued within a pension from a time when the individual or their company’s pension arrangement contracted out of the State Second Pension (S2P), formerly known as the State Earnings Related Pension Scheme (SERPS). Instead of building up secondary state pension, the government pays an annual rebate into the individual’s plan for the time they are contracted out. Several years of rebates, along with some reasonable growth, have seen some significant Protected Rights benefits.

As it currently stands, individuals who are or have been members of a contracted out arrangement accrue Protected Rights benefits. Pension holders crystallising any Protected Rights benefits by way of an annuity must incorporate a 50% spouse’s pension where they are married or within a civil partnership. A joint life annuity will obviously provide a lower income than on a single life basis. These annuity rates are also calculated on a unisex basis which disadvantages men who statistically have a shorter life expectancy than women. From April, individuals will no longer be compelled to buy a spouse’s benefit or unisex benefit, unless they wish to, giving them greater flexibility and potentially a higher annuity income.

As well as a benefit to annuitants, these changes will impact on those with larger pension pots wishing to take advantage of flexible drawdown through the Minimum Income Requirement (MIR). Currently individuals that can secure a guaranteed income of £20,000 by way of State pension, an annuity, a scheme pension or a final salary pension can take the remainder of their pension benefits as a lump sum. 25% of this amount is tax free with the remainder taxed at their marginal rate. Those benefits which are Protected Rights currently cannot be used as part of flexible drawdown benefits. From April this will change, meaning that pension holders can in theory withdraw a far greater amount of pension.

This legislation change is great news for many future retirees, giving them far more flexibility and choice as to which pension benefit best suits their circumstances. Pension holders with smaller pension pots will no longer be forced into providing for a spouse who may not require any provision at a time of historically low annuity rates. The changes will enable a higher single life annuity income to be sourced. In addition, those with far larger pots and with other secured pension income will, in theory, be able to extract larger sums from their pensions. This will offer individuals and their advisers greater opportunities around Inheritance Tax Planning and the passing on of wealth.

Matt Hawkins

Chartered Financial Planner

MillionPlus Financial Planning

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To Fix or not to Fix?

Those with significant pension assets should take action in advance of the changes in pension legislation coming into effect from 6 April 2012. Under existing rules, those with accumulated pension benefits in excess of the Lifetime Allowance (LTA) of £1.8 million currently face a potential tax charge of up to 55%. Changes announced in last year’s budget will see the LTA reduce to £1.5 million from this April, impacting many high earners and those with larger pension arrangements.

As an interim measure individuals can apply for Fixed Protection, securing the higher LTA limit, although the rules mean that all future pension contributions must cease. An individual’s LTA is the cumulative value of all defined contribution and defined benefit pension arrangements and includes any benefits already taken. This reduction from the current £1.8 million to the new £1.5 million LTA could leave a client up to £165,000 worse off without Fixed Protection.

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