On 6 April 2006 (known as A-Day) the pension system will be overhauled and the confusing array of eight pension schemes will be simplified. This change will affect every individual and every employer in the UK.

Under the new rules individuals with benefits in excess of the statutory lifetime allowance of £1.5m face a potential tax charge of 55% on the excess.

The revision to pension rules gives people an opportunity to tailor their retirement planning more closely to their personal needs. Self-invested personal pensions (SIPPS) might be a good option to consider for people close to retirement.

From 2006/07 annual contributions up to £215,000 per individual (limited to the higher of £3,600 or 100% of earnings for personal contributions) will qualify for tax relief; this amount will be increased annually to reach £255,000 in four years time. Excess contributions will not qualify for tax relief and will be added-back to the individual’s taxable income.

There will be a lifetime individual allowance of £1.5m – this will also rise by £300,000 over the next four years to a cumulative £1.8m. For people in defined benefit schemes there will be a multiplier used to calculate a ceiling and the excess will be subject to a tax charge of 55%.

The exact chart of the lifetime allowance changes is as follows:-

2007/08 - 1.6m
2008/09 - 1.65m
2009/10 - 1.75m
2010/11 - 1.8m

It is not at the present time clear whether the annual allowance of £255,000 in 2010 will be reviewed and, if so, whether this will just take place every five years.

Contribution limits -

Individuals can make unlimited contributions up to 100% of earnings. Employers can also pay unlimited contributions, although amounts in excess of the annual allowance will incur a 40% tax charge payable by the scheme member. For example: employee pays nil, employer pays £250,000 into the employees pension on 31 May 2006. As £35,000 (250-215,000) of this amount exceeds the employees annual cap, a personal tax charge of £14,000 falls on the employer. Note that the company receives full corporation tax relief on the full sum.

Draw down benefits will be the same for both defined contributions and defined benefit schemes.

The lump sum entitlement will be 25%. Individuals entitled to larger lump sums at the moment can try and protect this benefit independent of any protection of other pension benefits.

After 2010 the earliest age from which schemes may pay benefits will increase from 50 to 55. Members who on 10 December 2003 had the right to draw pension benefits before 55 may have that right protected. Pension payments can be deferred up until the member’s 75th birthday.

Because of the lifetime allowance, the opportunity to make large one-off payments may be reduced. Investment rules governing loans to a company from a pension scheme may be tightened up. This can mean SSAS schemes become less attractive and urgent meetings with your SSAS manager can help with pre A-Day planning.

The concept of normal retirement age will no longer feature in the rules. This will mean that there will no longer be a need to retire or break employment in order to access pension benefits. You may wish to maximise your funding under the current rules pre 5 April 2006. You may also wish to check whether your pension fund or tax-free cash sum requires protection.

You may wish to review the investment strategy both before and after the changes.

You may wish to consider consolidating benefits under an ex-employers scheme with other pension benefits or arrangements.You may wish to forecast your likely retirement age and consequential planning measures.

Alternative secured pension will effectively allow people to purchase annuities at age 75 and pass the fund on to dependants after death. This is a highly innovative change in the regulations, but requires further detailed legislation. Historically, one of the drawbacks of certain pension schemes was the requirement to take a compulsory annuity and any flexibility in this direction would be highly welcomed. Investing in residential property after A-Day and the possibility of bequeathing a pension fund to family members on death are two dramatic changes which may require detailed review.

If you enjoy final salary rights, it is vital that you take independent financial advice before you put at risk those final salary potential benefits whether or not the transfer into a SIPP offers you additional flexibility.

SIPPS are allowed to borrow up to 75% of the cost of commercial property – this borrowing facility will be cut to 50% of the fund value after A-Day. Loans to the SSAS linked company can be unsecured.

The ceiling of shares held in the SSAS limited company will reduce after A-Day from 50% to 5% of the fund.