Pensions A Day for Doctors & Dentists

Pensions are one of the most tax-efficient and effective ways to save for retirement, but working out how much to save and deciding which type of pension is best often feels like a complicated business.

The good news is that since 6th April 2006, known as “A-Day”, life got easier for retirement savers as the government introduced a new simplified set of rules, effectively shelving the eight previous tax frameworks for pensions.

The changeover means it ought to be easier than ever to begin calculating how much you’ll need in your pension pot by the time you retire. The new rules will also give savers far greater freedom in how and when pension benefits are taken.

Pensions have long offered attractive tax breaks. This means for higher rate taxpayers a contribution of £100 only costs £60 and for basic rate taxpayers the same contribution costs £78, with the Government providing the £40 and £22 respectively in tax relief.

Simplification ought to take some of the mystery out of pensions, but with the new flexibility comes new dilemmas for would-be savers, as well as those already building up their retirement nest eggs. 

New Limits

One of the main changes that occurred on 6th April 2006 was that, regardless of the type of pension you may have, you’re able to pay up to one annual allowance for that tax year.

This amount is up to 100 per cent of your earnings and for the tax year 2006/07 this allowance is capped at £215,000, with the limit set at £3,600 for low or non-earners paying into personal and stakeholder pensions. This replaces the previous lower limits that were linked to your age. This annual allowance will increase each year.

More Tax Free Cash

If you have an Additional Voluntary Contribution plan, whether in-house or free standing, April brings good news. As you may be aware, when you started investing into the plan there may have been no option to take tax-free cash when it came to drawing the benefits. Since April 2006, you have been able to take 25 per cent tax-free cash on the whole fund.

Pension Size Limits

After A-Day a new limit on the amount of money built up within your pension was introduced. In the tax year 2006/2007 this amount is £1.5million, with the threshold rising over the years to allow for the impact of inflation.

This is also the maximum amount that can be paid out as a tax free lump sum to your beneficiaries in the event of your death, giving much greater flexibility to provide death benefits via pensions after A-Day.

Introducing one lifetime limit for pension fund size effectively ends the sometimes complicated calculations savers could be forced to work through under the old pension rules.

A further innovation under the new rules is that the value above the lifetime limit will be subject to a new tax charge known as the lifetime allowance charge, or recovery tax, which will be charged at up to 55 per cent.

This measure is aimed at curtailing the amount of tax relief individuals can get from pensions.

The lifetime limit relates to your entire pensions savings, including any private pensions, NHS pension, free-standing additional voluntary contributions, in-house AVCs and Additional Service.

Protecting your fund

In the run-up to April 6th 2006 some pension savers who had already broken the £1.5 million pension threshold were able to shield their savings from the lifetime allowance charge or, alternatively, maximise tax breaks under the current rules.

It’s possible to register your pension fund value built up before this date to protect it against the lifetime allowance charge and you have until April 2009 to do this, although the sooner you understand your options the better you can plan accordingly.

The first thing you may want to consider if you are at or near the lifetime limit is getting a valuation of your entire pension savings, before considering putting certain protective measures in place, which will protect the fund from the lifetime allowance charge.

There are two levels of protection available.

‘Primary protection’ is available to pension funds over the £1.5 million lifetime limit on A-Day.

Going for primary protection will shield the value of the pension you have already built up and can potentially allow it to continue to grow in line with the increases in the lifetime limit without triggering the recovery tax charge.

‘Enhanced protection’ is available to any fund regardless of its size. Roughly speaking, this shelters not just the current value of pension savings, but also the full value of future investment returns, without incurring a tax penalty. 

This is provided that no further contributions are made or, if you are a member of the NHS Pension, that your benefits do not increase above certain limits and no new benefits are built up in respect of your employment after A-Day.

Most experts agree that ensuring you have a plan in place to protect your savings in preparation for pension simplification is an area where you will almost certainly need advice and struggle to do-it-yourself. Anyone with a
pension pot worth more than £1million will almost certainly need guidance.

Taking your pension benefits

If you have any AVC or personal pension funds (including Self Invested Personal Pensions), then when you come to retire your income is normally secured by the purchase of an annuity.

An annuity is effectively a promise to pay you an income for the rest of your life and is sometimes described as ‘insurance against living too long’, because with an annuity, your income from it lasts as long as you do.

Since 5th April 2006 individuals are still compelled to take benefits from their pensions by age 75 as they were before. However, the new pensions rules offer far greater flexibility over how benefits are taken.

For example, A-Day allows the introduction of new types of annuity.

‘Limited period annuities’ permit you to buy annuities in smaller chunks, each spanning a five year term, while the rest of your fund can be left invested. This will give individuals more choice on when to buy annuities and also allows them to maintain more control over their pension fund.

New ‘value-protected annuities’ respond to one of the key criticisms of annuities, that is, if you die very shortly after buying an annuity, your family loses out on your life’s savings because the money is absorbed by the collective fund of an insurance company’s annuity policyholders.

If you die ‘early’ your money is effectively absorbed and re-distributed among those who live longer.

Roughly speaking, under value protected annuities, if on death the money used to purchase the annuity has not been used up by an individual and they are under age 75, the balance can be paid to the policyholder’s estate after a tax charge of 35 per cent has been deducted.

However, it is essential to stress this potential benefit will be reflected in the rates for protected value annuities, which could be notably lower than on regular annuities.

‘Unsecured pensions’ were also introduced on A-Day.

This is similar to income drawdown under the old rules, where investors do not buy an annuity, but can take the tax-free cash sum and leave the remaining fund invested and income is taken from the invested fund and returns. Unsecured pensions can be used up to age 75 and policyholders can take up to a maximum amount up to 120 per cent of the annual income payable from a single life, level annuity. There is no minimum amount.

Under the new pension rules, once you reach age 75 you will have to purchase an annuity, if you have not already done so, or go for a new option called an ‘alternatively secured pension’ (ASP).

Although less attractive to pension members who need to rely on their pension income, for some people ASPs can work as a ‘family’ pension plan with your spouse, children and yourself as members, providing the facility to pass pension assets to your children's pensions, for example.

Under ASPs, your spouse or dependants can either buy an annuity or continue to draw an income from your fund after you die. If there is no spouse or no dependants, the pension value or assets can be paid to another member of the pension scheme or a charity.

The Key Considerations

Funding for your retirement is one of the largest investments you’ll make during your career. It makes sense to take the time to find out exactly where you stand now, as taking action too late may cost you. Speak to your Financial Adviser or do as much research as possible to get the answers you need.