New-age pensions promised, but don't bet your house on it

Reforms that include putting property in your fund may not see the light, says Melanie Bien

One of the Government's biggest challenges is persuading us to save more for retirement. Although increased funding for the NHS and schools is important, many people are worried about their futures - and whether they are going to be able to cope financially.

The delay in meaningful pensions reform is only making matters worse, as more people put off starting a pension until the Government announces its plans. However, in last week's pre-Budget report there was finally some movement. It was announced that reform will finally come into force on 6 April 2005 - known as "A" day - when the complex pensions system will be simplified.

There was one big surprise in Gordon Brown's comments: residential property holdings will be allowed to be included in pension funds. In theory, this will mean that investments in bricks and mortar qualify for capital gains and inheritance tax breaks if the property is sold or passed on.

Independent financial adviser Hargreaves Lansdown describes the move as "nothing short of astonishing".

"It is hard to reconcile the Chancellor's stated ambition of controlling the housing market's disproportionate influence on the economy with a proposal which will allow several hundred billion pounds of pension fund money to wash into the housing market," says Tom McPhail at Hargreaves Lansdown.

Self-invested personal pensions (Sipps) providers are thrilled as it means that not only buy-to-let property but even a person's own home can be held in a pension. And with £10bn invested in buy-to-let property in the past year, according to ludlowthompson.com, the residential property agency, it is likely to prove a popular move among investors.

Because the legislation concerning real estate property trusts, as they will be known, is not due to be published in draft form until the Budget in the spring, it is not yet clear how they will work. "It sounds like some positive news for property investors if the trusts have any meaning to them," says David Gibbs, tax partner at accountants Grant Thornton. "I hope they turn out to be a user-friendly investment that people can understand and relate to, not institutionalised like unit trusts. If they are more like property partnerships, the investor will be able to "feel" a sense of ownership of the underlying property."

Jim McCaffrey at Scottish Widows warns that tying up residential property in your pension could cause problems. "The lack of liquidity in bricks and mortar could create a problem as you have to purchase an annuity by the age of 75," he says. "Not only will you have to sell your home to get your hands on your pension, you will also have to sell it by a certain date - which might not be the ideal time to get the best price for it."

But before pension providers get their teeth into the details, there is a danger that such reforms won't even see the light of day. This is because the Chancellor also announced that the National Audit Office (NAO) will investigate further whether the lifetime limit for investment in a pension, £1.4m, is appropriate. The NAO will report back next March, but the Chancellor has suggested that if the cap isn't accepted then the whole simplification process will be abandoned.

Kevin LeGrand, head of technical services at Mellon Human Resources, comments that since the industry has been asked to respond to last week's proposals by 5 March - "just days before we may be told the whole idea has been abandoned" - it could be a complete waste of time.

Some concessions have been granted: if the value of a pension fund exceeds the £1.4m cap, the excess will be taxed at 55 per cent, rather than 60 per cent as previously suggested. Those benefits accrued before the cap is introduced, if indeed it is, will also be protected.

Other proposals that might be dropped if the cap isn't deemed appropriate are those aimed at making it easier to invest in a pension. Currently, you can invest a certain percentage of your salary each year, according to your age. Under the reforms, you will be able to save the equivalent of your annual earnings, or £200,000 (whichever is the lower), in a pension each year. This will be increased in line with prices.

However, the £200,000 limit won't apply in the final year before retirement. Mr McPhail at Hargreaves Lansdown believes that this "looks like a concession to the CBI to allow substantial payoffs to high earners at retirement".

Although it claims that simplification is its ultimate aim, the Government can't resist introducing another term: "alternative secured income". This replaces income drawdown, enabling pensioners to defer buying an annuity, though it isn't possible to get away with not purchasing one by the age of 75, even if you have opted to enter into drawdown.

New rules will make it possible for anyone under 75 to pass their pension fund on as capital to their dependants, after tax has been deducted at 35 per cent. If you die over the age of 75, you can leave only income to your dependants, not capital.