Start planning today for the pensions revolution

James Daley explains how to use new pension reforms to help you achieve your retirement dreams
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The Independent Online

Next April, the laws governing pensions will undergo their biggest overhaul in nearly 100 years. The rules on how much you can save, what you can invest in, how you will be taxed, and how much you can withdraw when you retire will all change significantly.

For pensions professionals, 6 April 2006 (when the new regime begins) has such significance that they are calling it "A-day" - the day when eight different pension tax regimes will be combined into one.

But this isn't just a technical exercise to excite those in the trade. After A-day, there will be new opportunities for millions of savers - and new problems too.

For anyone who wants to retire on a decent income - let alone early - it's important to plan ahead, with the help of an independent financial adviser. You can make some gains even before next April and there will be other ways to benefit after A-day.

Next year's relaxation of the rules on pension investments has already captured savers' imagination. From 6 April, you'll be able to hold residential property in a self-invested personal pension (Sipp) for the first time - other assets, including fine wines, artworks, antiques and even racehorses will also be allowed.

However, the fact that the new rules will allow you to hold buy-to-let properties - or even a holiday home - in a pension fund, doesn't mean you should do so.

Within a pension, income and capital gains from a property will be tax-free, but there are problems too. To crystallise the value of your investment, you will eventually have to sell it. So if it's a holiday home, for example, you may be forced to sell up just at the time you are getting the most use out of it. Or you may have to sell a buy-to-let investment at the wrong stage of the property cycle.

Antiques, racehorses and other alternative investments are even riskier bets, though all sorts of assets can help you save for old age - especially if your pension fund is large enough to enable you to hold a well-diversified spread of assets.

Tom McPhail, the head of pensions research at Hargreaves Lansdown, the Bristol-based financial advisers, says several companies are already considering launching pension funds that invest in stamps. Residential property funds are likely to be launched by the dozen.

More relevant for many people is a change to the rules on how much you can save in your pension each year. The current rules, which use a complex sliding scale depending on your age and earnings, will be scrapped. Instead, you will be allowed to contribute a sum equal to your annual earnings.

The only limit is a maximum annual contribution of £215,000 (except in your final year before retirement, when there is no limit at all).

These rules will then be subject to one overall lifetime pension fund limit - to keep its tax advantages, your pension fund must not exceed £1.5m. This limit will rise to £1.8m by 2010 and may rise in the future.

This limit is on fund size - not contributions, so investment growth may take you towards the cap. Even so, Kevin Neal of Clerical Medical points out that for the majority of earners, the lifetime limit will never be a factor.

However, those who are worried can take steps now to protect themselves. In theory, assets worth more than the limit when you retire will be taxed at punitive rates - as much as 55 per cent. But those who already have more than £1.5m can register their funds with the Revenue before A-day. You then pay no tax on your savings so far, though future gains may be chargeable.

For the wealthy, it's worth building up your fund as much as the current rules allow before the new rules comes into place.

Those close to retirement may also need to take action. Under the current rules, savers can take 25 per cent of their pension funds as tax-free cash when they retire - sometimes more in older schemes.

From next April, you'll still be able to take 25 per cent but not until age 55, rather than the current 50. More positively, you'll be able to take the cash when you want, rather than being forced to wait until you start drawing a pension from your savings.

McPhail points out that the current rules are subject to abuse. Some unscrupulous advisers advertise the benefits of "unlocking" your pension, which has persuaded people to use their pension fund at a much younger age than is prudent.

"Buy a pension early and you'll get much less income," McPhail warns. "After A-day, the fact you don't have to draw an income straight away makes it more acceptable to release cash early if needs be."

On the other hand, the new rules will stop people taking any more than 25 per cent tax-free cash unless they're already in an older scheme which allows for a larger withdrawal.

So if your company allows you to draw up to a third of your fund tax-free at retirement, transferring your pension after 6 April would require you to sacrifice this benefit.

A-day also offers flexibility to those who want to continue investing their savings for as long as possible. At the moment, you must convert your pension fund into income before your 75th birthday, by buying an annuity.

Under the new regime, you will have the option of an "alternatively secured pension" (ASP). You can leave your fund invested, and draw down up to 70 per cent a year of what you would have received had you bought an annuity.

ASPs have an advantage for your heirs. With an annuity, any money remaining in your fund when you die is passed back to the insurance company. In an ASP, the money is first used to provide a pension for your dependents. If there are none, it can be passed down into the pension fund of a friend or relative of your choice (after an inheritance tax charge if it's due).

Finally, the new rules will enable people with small pension funds (worth less than 1 per cent of the lifetime limit), to take their entire fund in cash. From April, this will be an option on pension funds of up to £15,000, compared to only £2,500 today.

Buy an annuity with a fund of less than £15,000 and you usually get poor value. So for savers with small funds coming up to retirement, it may be worth waiting until next April to take your pension.

Seven action points to consider before A-day

If you have a pension fund worth less than £15,000 and are about to take 25 per cent as tax-free cash, consider waiting until April. The new rules will allow you to cash in your whole fund without buying an annuity.

If you're in an older occupational pension scheme that allows you to take tax-free cash of more than 25 per cent, it may be worth protecting these benefits from the new rules. Seek financial advice.

If you have more than £1.5m in your pension fund, you must register it with HM Revenue & Customs before 6 April to protect it from punitive taxation in the future.

If you are buying a second property for investment purposes, consider waiting until April. You will then be able to hold property in pensions, protecting income or capital gains from tax. But look at whether you have enough cash in the fund for the purchase.

If you need to take tax-free cash from your pension fund for an emergency, ignore unscrupulous advisers offering "pension unlocking". Releasing cash will be easier after next April.

From next April, it will be easier to avoid buying an annuity, so don't rush into an income drawdown plan today, currently the only way to defer purchasing an income with your pension fund. The new rules will also make it possible for you to bequeath unused pension savings to your heirs.

Even if A-day does not immediately affect you, this is a good opportunity to review all your pension arrangements. Seek specialist financial advice if you think you may be affected by the new rules.

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