March 2002

TAKING ADVANTAGE OF THE CHANGING PENSION ENVIRONMENT

With the current poor investment market returns and lack of confidence in any imminent improvement, many people may be wondering why they should continue paying money into a pension fund. Bob Thomas, corporate financial consultant at Acumen Financial Planning Limited in Aberdeen, discusses the implications of the recent Green Paper and Inland Revenue Review focused on pensions.
The pensions industry has gone through various shake-ups over the years, the most recent being the introduction of yet another pensions regime on the already cumbersome pension world - the stakeholder pension. Unfortunately what the government thought was going to be the solution for all its long-term pension funding concerns, has not worked to the level initially hoped.
The tax breaks that are currently available, especially for high earners and owners of successful businesses, still make a compelling argument for an element of an individual’s future income provision to be made via a pension. Individuals can obtain tax breaks while retaining control of the investment timing, by keeping funds in a low risk environment or even cash – pension planning does not always have to equate to investment risk.
As a result, a recent Green Paper has been introduced to open debate on the simplification of the pension environment. The Government is looking to reduce the pension regimes from the nine currently in place to one, with the proposed changes being introduced as early as April 2004. Often changes can be seen as Government interference, but in this case consumers are welcoming the majority of the suggestions.
The proposed changes will remove overnight a lot of the complications and barriers that surround occupational pensions and are intended to encourage people to make increased contributions towards retirement. They will make the funding of schemes and the calculation of individuals tax free cash much easier, as well as simplifying the procedure to take the benefits of the scheme in later life. Both personal and occupational pensions will fall into the one regime rather than the confusing system currently in place, where an individual could easily have accumulated pensions in four or five of the regimes over a working life and not be aware of how they interact.
The significant changes are that the revenue will allow a pension contribution of up to 100% of taxable earnings to be paid each year by the employer subject to a maximum of £200,000 in any one year. This is a radical move and the new system will mean that in a working lifetime the tax benefits will be available on funds that are not in excess of a proposed cap of £1.4 million. It is anticipated that both these limits will be index-linked going forward. It should also be noted that the creation of a cap on the upper level of a fund size initially at £1.4m would only affect a minority of the population.
The latest proposals would be a major improvement to the majority of members of occupational schemes and would allow all individuals who have accumulated pension funds to access up to 25% of their total accumulated funds, by way of a tax free cash lump sum at retirement. This tax-free cash is a function of length of service and salary, with more recent schemes providing a maximum of one and a half times final salary after 20 years service. This system has only been available to personal pension and now stakeholder pensions, with the other regimes having various restrictions.
This means that there is an opportunity even before the new single regime is introduced to benefit from both sides of the legislation. There is the opportunity to use the current position to fund at a higher level, obtaining significant savings in corporation tax. There is also the opportunity to utilise the proposed changes to get those funds out tax efficiently, thus saving on personal income tax at a later date.
The pensions industry as a whole is in a state of flux and has suffered some scathing attacks in recent years, a lot of which have been justified. However, there are still some very compelling reasons to utilise the opportunities that they provide as part of a balanced portfolio for your future, especially if these can be provided in a transparent and understandable format.