Retirement in depth
Pension changes
June 2006
Changes to the pension system came into force on 6 April 2006. We explain what these changes are and how they’ll affect you.
If you are about to retire the pension rules may have major implications on how you get your pension. If retirement is a long way off, now is the time to review your pension arrangements to make sure that you are taking advantage of the changes.
How much can I save each year?
Pension contributions used to be based on age, type of pension and earnings. New contribution limits mean that you’ll be able to pay the higher of £3,600 a year or 100 per cent of your UK earnings into a private pension or a mixture of private pensions – employer’s, personal or stakeholder pension.
A limit is imposed on how much your savings can grow tax-free in any one tax year. In 2006/2007 your fund can grow to a maximum of £215,000. This limit is set to rise to £255,000 by 2010/2011. Savings growth over the limit is taxed at 40 per cent.
The annual allowance does not apply in the year before you retire, so your savings can exceed the limit and still qualify for tax relief. This mean you can move savings over from other sources and get tax relief.
How much can I save in total?
There is a limit on how much you can save over a lifetime. The lifetime allowance for 2006/2007 is £1.5 million. The limit is set to grow to £1.8 million by 2010-2011.
Any savings in your pension above this limit will be taxed at 25 per cent if you take it as pension and 55 per cent if you take it as cash.
When can I get my pension?
The minimum age you can take a private pension will rise from 50 to 55 in April 2010. If you want to retire before then you will have to use income from other sources, unless your scheme allows you to retire earlier.
If you have a company scheme you may be able to begin taking your pension while still employed if you cut down your hours and work part time if your company allows this.
How much cash can I take from my pension?
The rules on how much cash you can take have been standarised. You can now take up to 25 per cent of any private pension fund as tax-free cash, provided the scheme allows it. The rest must be taken as income.
If the total of your private pensions is worth 1 per cent or less than the lifetime allowance, you’ll be able to take the whole lot as cash. Of this, 25 per cent will be tax-free. The rest will be taxed as income for the year in which you receive it.
To be able to do this you must be aged between 60 and 75 and must convert all your pensions into cash within a one-year period.
What happens to the rest of my pension fund when I retire?
You have to convert your pension fund into an annuity by the time you reach 75, unless you top for a new alternatively secured pension.
One of the main criticisms of annuities is that if you die shortly after buying one, your pension pot goes back to the insurer and not to your family, unless you have a joint life annuity, in which case a proportion of your annuity passes to your partner.
Value-protected annuities are now available. If you opt for one of these and you die before age 75 your pension pot is returned to your estate, less any income that has already been paid out and 35 per cent tax.
You pay for this benefit by receiving a lower starting income than you would get with a traditional annuity.
If you die after 75 your pension will go back to the insurer as with a traditional annuity.
What is an income drawdown scheme?
These allow you to keep your pension fund invested until you reach 75, but take money to help fund your retirement.
You can choose to take up to 120 per cent of your available annuity income. The idea is that the growth of your fund should make up for some or all of the income that you take from it.
This is a high-risk strategy and should only be considered by those with large pension funds as could lose out if your fund suffers from a poor returns.
If you die while your funds are drawndown your dependents will inherit the money as an annuity. The income from this will be taxed.
How will the alternatively secured pension (ASP) work?
An ASP is a more limited form of income drawdown and will be suitable for people with a large pension fund.
With an ASP you can choose to take no income at all, or up to 70 per cent of your available annual annuity income. When you die, any remaining pension fund is used to provide a pension for a dependent. It won’t be added to your estate. A tax will be charged on this.
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