Pension Simplicity – A Mutually Exclusive Concept?

Brian Spence

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The words ‘simple’ and ‘pension’ rarely sit well together. Indeed it is the government’s view that it is the level of complexity inherent in buying a pension which prevents people from saving adequately for their retirement.

Whilst there is undoubtedly some truth in this, it is far from the whole story. Pensions just aren’t ‘sexy’ and, at a time when young people in particular have other drains on their finances, such as mortgages, and when many have suffered from poor investment returns, pensions tend to take a back seat.

But the fact remains that we all need to make some provision for our old age and that we would likely be more committed to do so if the investment we were making wasn’t so clouded by jargon and mystique. It is with this in mind that recent proposals incorporated as part of the Finance Act 2004 were issued and are likely to be implemented from April 2006.

Whilst that date might seem like a long way off, the interval between then and now marks a critical period for employees, trustees and pension holders, providing, as it does, a final opportunity to make sure you make the most of the benefits you’ve already built up or to make an informed decision about whether you should begin your pension saving before or after 2006. Indeed, certain key decisions might need to be taken within the next nine months.

The new proposals will introduce an annual limit which any individual will be permitted to build up in a tax privileged pension pot. This will be set initially in April 2006 at £1.5m, with a more penal tax regime then applying to funds built up above this level. Although the proposals have an almost universal impact, this is the area of the changes that has received most publicity and led many to believe, quite wrongly, that only ‘fat cats’ will be affected.

The proposals will allow pension holders to take up to 25 per cent of their pension pot (subject to the lifetime allowance) as a tax free lump sum and even though it’s likely that for many people this will provide at least the same or potentially even improve the amount of tax free cash that can be taken, this will not be the case universally. Individuals who are members of occupational pension schemes could be entitled to tax free cash amounts above these levels, but in order to maintain their entitlement, they will need to identify these and take action to protect them.

In addition, whilst much of the new regulation will be incorporated automatically in pension scheme rules, pension scheme trustees will maintain discretion in many areas, such as the level of tax free cash provided. This will undoubtedly lead to anomalies between schemes, resulting in members having different scheme entitlements to those which would be permitted by the legislation.

Whilst it is true that the lowest allowable retirement age will be raised from 50 to 55 from 2010, the limited impact of this should be more than compensated for by the level of increased flexibility available on contributions, investment and flexible retirement.

Personal contributions will be allowable at up to 100 per cent of salary, replacing the current 15% occupational contribution limit and the variable percentage scale which was applicable to personal pensions which ‘maxed out’ at 40 per cent. The maximum employer contribution will be set initially at £215,000 with the link to earnings and service in occupational pensions and the resultant complex contribution formula abandoned. The removal of the earnings link should add greater pension flexibility when dividends are being used as part of a remuneration package.

The new regulations will introduce a universal ability to draw a pension whilst still in employment, which should prove popular, as should the ability to invest in residential property, with foreign holiday homes looking a favourite, even when subject to a likely additional tax charge.

There are even provisions which will make pension contributions more attractive for low earners and part-timers, especially where an employer contribution is available. New rules will allow more benefit to be taken in lump sum format rather than via small annual pensions which are often tax and state benefit inefficient.

There is much progress in the new proposals, which should provide a simple new framework going forward. In the run up to April 2006, though, there is a lot of work to be done and many decisions to be taken.

I am reminded of the joke about the man asking for directions in Dublin being greeted with “Well sur, to get there I wouldn’t be wanting to start from here!” Unfortunately for employers, trustees, employees and advisers ‘here’ is exactly where we are.

ENDS

Brian Spence

Post by Brian Spence

Fellow of the Institute and Faculty of Actuaries and Society of Actuaries in Ireland, scheme actuary, professional pension trustee

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