ACTION BEFORE 'A' DAY
The date the new tax régime for pension funds takes effect – 6 April 2006 – has been dubbed ‘A’- Day.
Although the new rules are generally more favourable to the pension saver, in some cases an advantage can be gained by taking action before ‘A’- Day.
· Under the new régime it will not be possible, as it has been in previous years, to claim tax relief for a pension contribution in the year before it was paid (usually referred to as ‘relating back’). Accordingly, anyone who wants to take the tax relief in 2005/06 – for example, because he has an exceptionally high income this year – needs to make the contribution by 5 April 2006.
· When a pension saver has accrued benefits under a Retirement Annuity Contract originally taken out before July 1988, it is possible that he will be able to take a greater proportion of his total pension fund as a tax-free lump sum if he begins to draw his pension before ‘A’- Day. This is particularly likely if the RAC offers a relatively high Guaranteed Annuity Rate. It is not usually possible to begin drawing a pension under a RAC before age 60.
· At present, it is possible to base pension contributions on the highest earnings in the last five tax years – thus it is even possible to pay substantial pension contributions after retirement. But from 6 April 2006 post-retirement pension contributions will be limited to £3,600 a year.
· If contributions made after 5 April 2006 take an individual’s total pension savings over £1.5 million, the usual pension fund tax exemptions on the excess will be clawed back. Therefore, if anyone wants – and is able – to put more than £1.5 million into their pension fund, they should do so before ‘A’- Day. However, this is not likely to affect many people!
· It is currently possible for the proprietors of a business to arrange for their pension fund to buy commercial property, such as a small office building, and then let it to their business. This will remain possible under the new régime but the maximum loan that the pension fund can take to help finance the purchase will reduce, from one equal to 75% of the cost of the building to one equal to 50% of the nett value of the pension fund (the same rule as for buy-to-lets). Thus a pension fund worth £200,000 could currently buy a commercial building for £800,000, but after ‘A’- Day could only afford one worth £300,000.
Wait until after ‘A’- Day
On the other hand, there will be situations where it will pay to wait until after ‘A’- Day.
· If benefits begin to be taken from a Free-Standing Additional Voluntary Contribution (FSAVC) Scheme before ‘A’- Day, they must be taken wholly in the form of a (taxable) pension. After ‘A’- Day, 25% of the fund may be taken as a tax-free lump sum. FSAVCs are sometimes used as a ‘top up’ pension for an employee or director who is also a member of a company pension scheme.
· After ‘A’- Day it will be possible for an individual, aged 50 or more, to make a substantial contribution to a pension plan and then immediately withdraw 25% of that contribution as a (tax-free) lump sum, leaving the remaining 75% to accumulate to produce a pension at a later date. For example, if a higher rate taxpayer contributed £20,000, the nett cost of a pension fund worth £15,000 would be only £7,000 (after 40% tax relief – £8,000 – and a £5,000 lump sum) – though this simple example does ignore the effect of the pension company’s charges.
IMPORTANT: This newsletter deals with a number of topics which, it is hoped, will be of general interest to clients. However, in the space available it is impossible to mention all the points which may be relevant in individual cases, so please contact us for personal advice on your own affairs.