In initiating the review, the Treasury has acknowledged the issues often caused by tax for people of pensionable age.

Around 5.6m people in the UK who are of pensionable age are currently in the tax system. The Treasury recognises that tax causes too many problems for this group of people who are the least able to cope with them.

In the Office of Tax Simplification review, they will be trying to identify which elements of the tax system cause the biggest problems for pensioners due to complexity. The review will also bring forward proposals to make the tax affairs of pensioners simpler.

An interim report is expected from the Office of Tax Simplification ahead of the Budget next year, with a final report and policy recommendations due to be published later in 2012.

It is worth noting that this review of pension taxation is not expected to look at the tax relief on contributions or the tax treatment of benefits arising from pension schemes. In this respect, income tax relief on pension contributions and ‘tax-free cash’ (the pension commencement lump sum) should be safe – for now!

Photo credit: Flickr/alancleaver_2000

As a result of changes to the pension rules which came into force on 6th April 2011, some people using Unsecured Pension (USP) have important decisions to make when they reach their 75th birthdays.

One of the changes to the Unsecured Pension rules is a change to the charge on death benefits should you die whilst in USP.

This death benefit tax charge, when benefits are taken as a lump sum, was previously 35% but has been increased to 55% since 6th April.

Whilst this previously did not apply to death benefits on pensions where the pension commencement lump sum (tax-free cash) had not been taken, it will now apply to these funds from the 75th birthday onwards.

For this reason, there is a strong argument for taking the maximum tax-free cash available from a pension fund shortly before age 75, as in the worst case scenario this part of the pension fund would then be subject to inheritance tax at 40% rather than a 55% tax charge. In doing this, it would not be necessarily to draw a taxable income from the remaining pension fund.

Another interesting discussion at the technical workshop looked at the Lifetime Allowance tax charge after age 75.

This applies to large pension funds which breach the Lifetime Allowance (£1.8m this tax year, reducing to £1.5m for 2012/13) and it was confirmed at the workshop that the option to take excess pension benefits as a lump sum after age 75 is no longer available.

What this means in practice is that the excess pension benefits would need to be taken as a taxable income, which is also subject to a Lifetime Allowance tax charge, and this results in a much larger effective tax charge than the lump sum option.

A final consideration discussed at the workshop looked at the ability to claim additional rate income tax relief at 50% for a future tax year when making pension contributions, even if the temporary 50% rate is withdrawn next year.

This is achieved through the use of pension input periods and involves a personalised strategy based on previous pension contributions and pension scheme membership in previous tax years.

It is a complex area of pension planning but something we are comfortable delivering to our clients where they can benefit from the use of pension input periods to maximise tax relieved contributions.

Keeping up to date with technical developments is an important part of our continuing professional development here at Informed Choice.

We always want to ensure that our team not only holds the highest levels of professional qualifications but also remain well informed when it comes to the technicalities we can apply to our recommendations for clients; helping our clients to build, manage and protect their wealth.

The plans could see individuals being able to access some of the value within their pension schemes before their minimum retirement age.

Since 6th April 2010, the minimum age at which you can access a pension commencement lump sum (tax-free cash) has been age 55. It was previously possible to access tax-free cash from age 50.

The new rules allowing earlier access are likely to come with some restrictions.

It has been suggested that the cash could only be used to fund specific activities, including educating children, housing and health care.

Increased flexibility is always welcome when it comes to financial products. Allowing earlier access to some of the cash within a pension fund for specific types of expenditure could ease the financial problems many people face each year.

If the new rules are introduced, people who choose to access their pension cash early will need to do so with care.

Even under current rules, those taking tax-free cash at age 55 but deferring a pension income until later need to think ahead to the impact this will have on their income in retirement.

It will be essential to seek professional independent financial advice, consider all of the options carefully and plan ahead to make sure you will still have sufficient pension income available in your older age.

Photo credit: Flickr/HowardLake

However, despite misgivings in many quarters before the Budget, he avoided any temptation to increase Capital Gains Tax, or to restrict the tax relief available to most individuals in respect of pension contributions.

Aside from restrictions on those earning in excess of £130,000 a year, anyone can achieve income tax relief at their highest marginal rate (up to 40%), by making a pension contribution.

Where this can really be of great benefit is for any member of a final salary pension scheme which offers access to an ‘in-house’ AVC arrangement (otherwise known as ‘Additional Voluntary Contribution), where the scheme rules permit the member to take up to 100% of the AVC ‘pot’ as a tax-free lump sum.

Whilst many final salary schemes have closed in recent times, a large number of employees (particularly those approaching retirement) still enjoy these valuable benefits.

Not all schemes allow the 100% tax-free lump facility, but, for example, the Local Government Pension Scheme (which has over 3 million members) will allow employees to pay up to 50% of their salary (100% in Scotland!) into the AVC arrangement, with the possibility of getting the whole of the AVC fund back (tax-free) at retirement.

Where this really starts to get interesting is when you consider that the AVC contribution benefits from tax relief, as it is deducted from salary before tax is calculated.

This means that, for example, an employee paying £1,000 per month into the AVC scheme, will benefit from a saving in tax of £2,400 over a year (or £4,800, if they are paying higher-rate tax), and will receive the whole of the AVC fund back as a tax-free lump sum (plus any increase in fund value), when they retire.

Perhaps not practical for someone who is a long way from retirement, but could be a very effective way of getting a tax bonus from the Government in the year or two before retirement.

In this example, they would only receive £9,600 per annum, after tax of the income, if taken as salary, but would get the full £12,000 in their AVC pot, if paid as a contribution.

That’s an increase of 25%, and needn’t involve any investment risk! I dare not even quote the benefit to a higher-rate taxpayer, as you may not believe me!

So, if you are one of the lucky ones in a final salary scheme, you could get even luckier, courtesy of that nice Mr Darling! Why not discuss this with your financial adviser?

Anyone who will be 50 before the beginning of the next tax year will have to make the decision whether it is appropriate to take their retirement benefits in whole, in part or to wait for up to a further five years.

Changes to the minimum pension age will mean the loss of access to pension benefits until age 55 with people at or approaching age 50 the most affected.

This article outlines the advantages of taking retirement benefits now plus warnings about doing so.

Advantages

1. Access to a Tax Free Lump Sum

Under current rules benefits from a pension scheme include a tax free lump sum equivalent to 25% of the fund value at retirement. This can be of great benefit where a capital expenditure is required, for example for home improvements, or to buy that dream car or, perhaps more prudently, to reduce a debt such as a mortgage.

2. Flexible Income

Contrary to popular belief an annuity is not the only income available from a pension. Unsecured Pensions (USP and also known as Income Drawdown) provides pension income that is more flexible.

It is possible to receive an income between nil and 120% of a rate set by the Government Actuary’s Department (the GAD rate). This rate is correlated to the yield available on Government Gilts and the individual’s gender and age.

This option is beneficial to those who require a capital sum but don’t want to receive any taxable income, those who want to start receiving a supplementary income and also to those who want the higher income than available via an annuity.

3. Continued Investment Growth

Unlike annuity purchase USP provides the opportunity to benefit from further fund growth because the pension fund stays invested. This can provide a higher level of annuity income when it is finally purchased.

4. Keep Contributing

Some USP contracts allow for pension contributions to continue despite having taken the tax free lump sum and income. This allows individuals to make use of the lump sum but to continue to build up their pension fund from which to take the guaranteed annuity income.

Contributions will continue to attract tax relief at 20% for basic rate tax payers with a further 20% reclaimable for higher rate tax payers.

Those earning £130,000 gross per annum or more should take note of the changes to tax relief announced in the 2009 Budget and Pre Budget Report.

Warnings

1. Worse Death Benefits

One significant disadvantaged of taking retirement benefits is worse benefits on death. Prior to taking benefits the pension fund can be passed to a nominated beneficiary as a lump sum free of any tax. Under USP this fund is taxed at 35%.

Worse still where an annuity has been purchased the pension fund can be lost entirely to the annuity provider. This can be mitigated against by adding options to the annuity that provide a dependants pension and guaranteed periods where the balance of payments continue to be paid for a maximum of ten years. However, when these options are added the starting income is reduced.

2. Loss of Tax Advantaged Growth

It is unwise to take the capital sum if it is not to be used. If the capital is only to be saved or invested it will have been transferred from an environment that grows free of tax (with the exception of a non reclaimable 10% tax credit on UK dividends) to one where both interest and capital gains are taxed.

3. Adding to Taxable Income

Unless an income is required any additional pension income (via any means) will simply increase the tax that is charged on total income at either 20% or 40% (and potentially 50% from April 2011).

4. Income erodes capital

If a USP contract is entered into and income is taken there is a risk that the income taken is greater than the investment growth received each year.

This will have the effect of eroding the capital value of the pension fund, which if occurs regularly or significantly in any given year, can be extremely detrimental to the final fund value used to purchased a guaranteed annuity income.

5. Loss of Purchasing Power

Annuity rates are determined by one’s life expectancy. The younger an individual the longer they will expect to live and therefore the greater income needed for life.

The result of this is a lower annuity rate offered by the annuity provider (they don’t want to pay more out in income than the original fund value they have received).

If a guaranteed income is relied upon for a long period of time (possibly for over forty years if bought at 50) the loss of purchasing power will be substantial over time as inflation reduces the value of £1.

This can be controlled by purchasing an annuity that increases each year either at a set percentage (3% or 5%) or by increasing in inflation (as measured by RPI). The disadvantage of this is that the initial annuity income provided is considerably less.

In fact, it can be in excess of ten years before an increasing income is equal to that of a level income.

This tax year therefore marks a key date for many and taking retirement benefits in any form can be extremely useful. However, care must be taken before irrevocable decisions are made.