New horizon: the skies clear for our sunset funds

Sam Dunn asks if new incentives to encourage us to save more will head off Britain's looming pension crisis
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The Independent Online

Any light that pierces the gloom enveloping the distant horizon of our pension provision is desperately needed.

Any light that pierces the gloom enveloping the distant horizon of our pension provision is desperately needed.

Half the UK's working population aren't putting enough by for their retirement, and a total of £57bn will be needed in extra savings if tomorrow's pensioners are to have the same standard of living as today's.

But soon we should be able to see more clearly. The first shaft of light should penetrate the clouds in the autumn when Adair Turner, chairman of the Pensions Commission, reports back with recommendations likely to include higher taxes, a later retirement age or more generous savings incentives.

The second is A-Day, 6 April 2006 - the date of a radical revamp of pension rules. Preparations are being made as insurers, financial advisers and occupational pension schemes look towards a new regime that will inject flexibility into what many now view as an out- dated retirement savings system.

One of the biggest changes is the scrapping of the current savings restrictions based on age, salary and the type of plan in which you invest - whether personal or company.

From 6 April next year, you will be able to put the equivalent of your salary into your pension fund each year - and qualify for tax relief. This annual "allowance" will vary but, for the 2006-07 tax year, you will be able to invest up to £215,000.

In effect, this means you can fast-track your pension. Say you have £5,000 in a bank savings account - you could put it straight into your pension fund, where it will grow tax free.

Another change is that buying an annuity by the age of 75 will no longer be compulsory. Instead, you will have the option of taking an "alternatively secured income" (ASI). This will pay a lower monthly (taxed) income but will allow you to pass on any unused pension after your death to a loved one.

Meanwhile, savers opting for a self-invested personal pension (Sipp) will be able to use it to invest in residential property - whether a buy-to-let, a holiday home or even their own house.

In the latter case, details have yet to be finalised, but Tom McPhail, pensions specialist at independent financial adviser Hargreaves Lansdown, says it might work like this.

An individual with a sizeable pension pot (say, £400,000), but who plans to work for another 10 years, cashes it in to buy a house. He then pays rent to live there and the money feeds back into his very own Sipp scheme, rolling up tax-free for as long as he's resident. When he's ready to retire, the property can be sold for cash that in turn buys a smaller home and an annuity.

Plenty of difficulties exist, including legal complexities over ownership and an individual's right to alter his own home - by building an extension, say - but "these will be ironed out", Mr McPhail predicts.

It is anticipated that properties inside the fund will be free of tax on rental income and capital gains.

Savers will also be able to use a Sipp to invest in valuables such as art or wine.

There will be other important changes. At the moment, any private pension pot worth less than £2,500 can be taken as a taxed lump sum instead of being used to buy an annuity. But, from 6 April, this limit will rise to £15,000.

Every company and personal pension scheme - including final-salary plans - will let you take 25 per cent of your fund in tax-free cash when you retire. And, in another reform, this figure can also now include any additional voluntary contributions (AVCs) made to your company scheme.

However, there will be a new "lifetime allowance" limit on the size of pension fund you can build up. This will start at £1.5m at A-Day itself and rise to £1.8m by 2010.

If you are fortunate enough to be able to amass a sum in excess of that, you will be taxed at 55 per cent on anything above this limit - unless you part-protect yourself by registering your fund with the Inland Revenue before April 2009.

These changes should encourage us to put more money aside, enthuses Steve Bee, head of pensions strategy at insurer Scottish Life. "The Government wants us to save in any way we can. It's remarkable. We're seeing the end of the old 'use it or lose it' pension allowance."

He highlights how, post A-Day, it should be possible to slice a tax-free cash sum from a company money-purchase scheme once you reach your 50th birthday (55 from 2010) without being obligated to take any more money out - in contrast to the current rules. You can then leave the rest to carry on growing, or even add to what's left (although you won't be able to take any further sums tax-free).

However, with this year's Finance Act still to be passed, there could be amendments to all these plans.

For today's younger savers in their 30s and 40s, A-Day is likely to offer plenty of opportunities, says Mr McPhail. But for those who had been about to retire but are now wondering if they should wait until after A-Day, whether to do so will depend on the size of the pension and of the fund.

For example, there are many final-salary com-pany pensions from the 1980s where you may still be able to withdraw a tax-free lump sum larger than 25 per cent - as long as you act before A-Day.

In most cases, specialist pensions advice will be a first port of call.

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