How to Benefit from the New Pension Regime

How to Benefit from the New Pension Regime
The start of the new tax year heralds many changes, including pensions. What are they, and who will be affected by these changes?


From 6th April 2011, there will be significant changes to the pensions’ regime.  These changes affect contributions to pension funds, the abolition of unsecured pensions (USPs) and alternatively secured pensions (ASPs), inheritance tax on pensions, tax on death benefits, and the phasing out of annuity compulsion, and a reduction of pension income under drawdown, as the main constituents.


The main benefit of making tax deductible pension contributions remains, albeit at a lower level (£50,000 per annum maximum contributions, as opposed to £225,000 annual allowance), but with the ability to accumulate unused contributions for the previous 3 tax years (note - you must have been a member of a registered pension fund in those prior years).  In the current year and 3 previous tax years you can contribute up to £200,000.  This position carries forward any unused reliefs.


What If I Don’t Have a Pension?

If you don’t have one, set up a pension fund now, with minimum contributions, then make lump sum contributions later, which will be tax deductible within limits.


Pension funds continue to have gross roll-up and there is no income tax or capital gains tax to pay within the fund.  25% in tax-free cash remains.  HMRC adds 20% to the contributions you make, thus expanding your basic rate tax band and higher rate tax limits by the amount of the gross contribution, and less tax is payable at the higher and additional rates. 


This can be useful for taxpayers as the top threshold for the basic rate tax band reduces from £37,400 to £35,000 in 2011/12, and you lose the personal allowance (progressively with income over £100,000). Contributions for higher and additional rate taxpayers are relieved at their highest rate, so 20% to 30% additional tax relief is available. 


Income Drawdown, Capped Drawdown & Flexible Drawdown

Make maximum contributions to reduce the overall tax you pay and preserve your personal allowance.


Significant changes to how you take your pension are being made.  From 6th April 2011, the overall process is known as Income Drawdown and the old definitions of USP and ASP (and drawing an annuity from age 77) disappear. 


There are also two new types of drawdown.  These are Capped Drawdown – similar to the previous USP position; and Flexible Drawdown, which allows you the option to take as much income as you like from the fund (including all of it at once), and to pay tax on it at your marginal rate if you do so. 


This is only possible where you have other income from registered pension funds and annuity funds of at least £20,000 (‘MIR’ – minimum income requirement) per annum.  There is now no maximum age to take your tax-free cash.


‘Maxing Out’ Your Pension Income

If you are not making pension contributions in the future, and have pensions from other sources of at least £20,000, you can ‘max out’ your pension income with no cap and be taxed at your marginal rates of tax.


Important changes to death benefits are made from 6th April 2011. If you die before age 75 and before drawing benefits, the fund can be paid to beneficiaries free of tax as a lump sum.  After age 75 there is a tax charge of 55% on the lump sum paid to beneficiaries before taking benefits.


If taking benefits, at any age, via capped drawdown, the tax charge is 55% when paid to beneficiaries, or tax free if paid to charity.  The old charges of up to 82% fall away and no IHT is payable.


Practical Tip

If in USP or capped drawdown and taking income, you can recycle pension income into another personal pension plan to have death benefits at 100% tax-free up to age 75.  On all pension schemes make sure that you have completed the nominated beneficiaries for death benefits. And as always, seek professional help from a pension adviser.


By Tony Granger