Pension simplification - Opportunities or obstacles?

As the countdown to pension simplification in April 2006 begins, Penny Bates explores the current planning opportunities.

Over the years pension funding has become increasingly complex resulting in the present eight different regimes. The legislation introduced in the Finance Act 2004 is intended to make things much simpler from (A Day) April 2006, although it must be recognised that the transitional rules are anything but simple. Further guidance will be forthcoming over the next few months but for now we must work with what we have.

This article briefly summarises the main changes and some of the planning opportunities, but detailed advice should be taken in every case.

Basic rules under the new regime Lifetime limit

The new lifetime limit will start at £1.5m for the year from 6 April 2006.

Planned increases follow each year as follows:

2007/08 - £1.60m

2008/09 - £1.65m

2009/10 - £1.75m

2010/11 - £1.80m

The allowance will be reviewed and set for each subsequent five-year period.

Testing against the lifetime limits will take place at the time of vesting of benefits.

Additionally, pre-A Day pensions in payment will need to be taken into account. A standard factor of 25:1 will be applied to pensions in payment in order to allow for the fact that tax-free cash may have been taken already.


Annual pension in payment £40,000 - £1,000,000 of lifetime limit has been utilised.

Annual contributions

For tax relief purposes, the overall annual allowance is to be set at £215,000 per annum for the 2006/07 tax year. This will then increase by £10,000 pa over the subsequent four tax years. The allowance will then be reviewed and set for the following five years.

Although the maximum an individual can contribute will be limited to salary or the annual allowance of £215,000, there will be no limit on the contributions that may be made by employers, but pension contributions over £215,000 will be tax inefficient.

Any contributions (or benefits accrued) in excess of the annual allowance will be taxed on the individual at 40%.

Employer contributions

Employer contributions to registered schemes are deductible for tax purposes, with statutory provision for the spreading of abnormally large contributions over a period of up to four years. They do not count as taxable income of the employee.

Pension age

Currently the minimum age for vesting benefits is 50 but this is set to rise to 55 by 2010.

It will no longer be necessary to cease service with the employer before taking benefits between the ages of 55 and 75.

The lower normal retirement ages applicable to people such as sports men and women will no longer apply under the new regime, but those with these rights at A Day will be protected.

Should the individual die before retirement, the whole fund up to the lifetime limit may be paid as a tax-free lump sum. In the event the member dies after drawing his pension, the whole fund can be repaid but will be subject to 35% tax.

Tax-free cash

At retirement, up to 25% of the fund within the lifetime allowance may be taken as a tax-free cash sum.

Where pre-A Day rules give higher tax-free cash sums, protection will be available to those with a tax-free cash sum entitlement of more than £375,000 (ie, 25% of the lifetime allowance) and also to those with an entitlement to a higher percentage than 25% of their pre-A Day fund.


Mr Black is a member of an occupational scheme (OPS) and the value of his pension fund is £200,000. His salary is £40,000 pa. Under the terms of the scheme, he is entitled to 3/80ths tax-free cash on retirement for each year of service. Mr Black has 19 years service. Mr Black is considering taking his pension rights in December 2005 when he will be 55.

Under the OPS, Mr Black's entitlement to tax-free cash will therefore be 3/80th of £40,000 x 19 = £28,500.

By delaying his retirement a few months until after 6 April 2006, his tax-free cash entitlement will be 25% of the fund, being £50,000.

Tax-free cash may be important to Mr Black but he should also consider the resulting reduction in annual pension income from increasing the tax-free cash.

Tax charge on over-funded contributions

Where contributions exceed the annual allowance, a charge of 40% will be made on the member and no relief will be available to offset allowances or losses. The self-assessment tax return will be amended to include the facility for an individual to self-assess this charge if applicable.

Planning opportunities

For those who have been fortunate enough to accrue pension funds in excess of the lifetime limit, there will be an opportunity to protect those funds.

There are two methods which are likely to appeal to different audiences.

Primary protection

This is available if the member has more than £1.5m in their pension fund on A Day. By registering it is possible to protect the value of the fund. For example, if a member has a pension fund valued at £3m, registration will mean that his lifetime allowance will be twice the standard amount.

Provided the value of the fund is no more than twice the lifetime limit at the time of vesting, no tax charge on the excess will be levied. The member may continue to make contributions to the fund but obviously a careful eye needs to be kept on the fund's increasing value and the lifetime limits. Primary protection may be of particular interest to members of final salary schemes.


Mr White's fund at A Day is £2m.

His lifetime allowance will therefore be increased by 1/3.

Value of fund at retirement in 2010/11 is £2.5m.

Primary protection increases 2010/11 lifetime allowance of £1.8m by 1/3 giving protected lifetime allowance of £2.4m.

Excess of £100,000 will be subject to recovery charge at 40% = £40,000.

Enhanced protection

Enhanced protection is available to members who will cease to contribute to their fund and is available to all regardless of the size of the fund at A Day. This means the whole fund is protected from any tax charge.

No further contributions can be made other than contracted out rebates of NIC received after A Day.

An individual who intends to benefit from either primary protection or enhancement must give notice to the Inland Revenue in accordance with regulations to be issued.

Investment opportunities

These will widen considerably from April 2006 and will include residential property and works of art. However, the fund's ability to borrow will be severely diminished to only 50% of the fund value.

Currently, self-invested pension plans (SIPPs) offer the opportunity to borrow up to 75% of the purchase price of commercial property. Typically, the SIPP would own and rent the property to the employing company. Rents paid to the SIPP would be deductible in the employing company accounts and free of income tax in the SIPP. The rents and any annual contributions are then available to service the borrowings.


Fund valued at £150,000 cash.

Borrowing limits pre-A day (SIPP) 75% of purchase price £450,000.

Maximum purchase price £600,000.

Borrowing limits post-A day - £150,000 x 50% £75,000.

Maximum purchase price £225,000.

Those with old style pension plans wishing to diversify could consider transferring all existing pension provision into a SIPP now to take advantage of these high lending rates.


Mr Jones has a personal pension currently valued at £100,000 and an old style retirement annuity contract currently valued at £50,000. These pensions are unable to take advantage of the SIPP investment opportunities. Mr Jones should take advice and consider transferring his current pension funds into a SIPP wrapper thereby giving the opportunity of investing in commercial property under the current advantageous borrowing rules.

Anyone considering the possibility of purchasing commercial property through a pension fund should take early advice on the advantages of consolidating existing pension funds into a SSIP.

Penny Bates is private client partner of Menzies chartered accountants based at Kingston upon Thames. The views expressed in this article are not necessarily those of the partnership and no responsibility will be taken for any reliance placed upon these

COUNTDOWN TO A DAY - timetable
31 January 2005 Deadline for payment and carry-back claims to 2003/04.
Now to April 2006 Take advice on existing arrangements.
  RAP carry-forward ends.
  Pension carry-back ends.
6 April 2006 Implementation of A Day.
6 April 2005 Gradual raising of the minimum retirement age to 55 begins.
6 April 2011 Completion of raising of the minimum retirement age to 55.
6 April 2010 Gradual raising of the female state pension age from 60 to 65 begins.
6 April 2020 Completion of raising the female state pension age to equal the male age of 65.
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