Page last updated at 09:26 GMT, Monday, 6 February 2006

Get ready for A-Day!

Money Talk
By Tom McPhail
Head of Pensions Research, Hargreaves Lansdown

Tom McPhail
Tom McPhail, Hargreaves Lansdown
Make a note in your diary for 6 April 2006 - it could mark the turning point in the declining fortunes of the UK pension system.

It could even be the moment when pensions start to get interesting.

What is A-Day?

On that date, a new set of pension rules will be introduced. They will replace much of the existing pension legislation which has been built up over previous decades.

This marks a crucial departure from past practice.

It is a genuine attempt to make the system simpler and more accessible to the millions of investors who have found pensions just too much of a headache to get to grips with.

The more that people can be encouraged to make their own savings out of income now, the easier the challenge will be for the government in the future.

What will it mean for us as individuals?

Many of the existing restrictions on how pensions can be used will be swept away.

From A-Day, if you want to be a member of a company pension scheme and save money in a personal pension at the same time, then you can.

If you want to start drawing your pension and carrying on working, then that's OK too.

New limits

The limits on what you can put in and what you can take out have also been simplified.

You can invest up to 100% of your earned income in any tax year, up to a ceiling of 215,000 - more than enough to keep most people happy, and receive tax relief at your highest marginal rate.

You can invest up to 100% of your earned income in any tax year, up to 215,000
You can build up a pension fund up to a lifetime limit, initially 1.5m
You can draw your 25% tax-free lump sum from your pension at the age of 55
You may no longer need to buy an annuity by your 75th birthday

Similarly, you can build up a pension fund up to a lifetime limit, initially 1.5m, before any tax restrictions kick in. There are transition rules for people who may already be close to this lifetime limit.

Further changes include being able to take 25% of your contracted-out personal pension fund as a tax-free lump sum, as will also be the case for Additional Voluntary Contribution (AVC) pensions.

You will also have more choice over how your retirement income is paid.

You could, for example, draw your 25% tax-free lump sum from your pension at the age of 55 and defer taking any retirement income until you actually retire, perhaps 10 years later.

This option is likely to be particularly popular for investors facing an endowment shortfall, or an impoverished child with aspirations towards a university education.

The requirement which forces investors to buy an annuity by their 75th birthday is also being partially abolished, although it looks as though any lump sum payouts on death after this age may become subject to inheritance tax.

So what does this all mean in practical terms?

If, for example, you have an AVC pension, then you may benefit from holding off your retirement until after A-Day, so that you can take 25% of your fund as a tax-free lump sum.

You will have more choice about when, how and how much you save into a pension

Also, new annuity options after A-Day may also mean that you can find more suitable terms on which to have your retirement income paid.

After A-Day, you will have more choice about when, how and how much you save into a pension.

So there's a fair chance that whatever you are currently doing about providing for your retirement, you may benefit from reviewing your current arrangements in light of the new rules.

What about employers and workplace pensions?

For employers, it's a case of once more into the breach.

The new contribution and benefit limits mean that they will have to rewrite their scheme rules to accommodate these changes.

In some cases, it may mean having to negotiate new terms with high earning senior executives who may, for example, not want any further pension benefits if they will breach the lifetime limit.

Employers will have to redraw their scheme booklets and notify their members of the changes.

The good news for them is that the government has given them until 2011 before they have to shift their schemes across to the new regime.

How much to pay in?

The crucial issue is how much is being paid into a pension.

Traditional final salary pension schemes have typical contribution rates, from staff and employer together, of around 16-20% of salaries.

Occupational money purchase schemes have contribution rates of around 12% of salary, and personal pensions typically only have around 6% of an investor's income being paid into them.

Taking the final salary pensions as a benchmark of how much we should be saving, it is clear that more needs to be done.

The government and the pensions industry is waiting with bated breath to see if the A-Day reforms will mark a turning point in our retirement planning.

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