10 answers to your questions about pensions and tax

How much should you save for a pension? What are the rules on taking a tax free lump sum? Confused about pensions and tax? We thought you might be. Adrian Walker, pensions expert at investments and pensions provider Skandia, has answered Citywire readers’ questions.

How much should I save?

‘I find it so difficult to calculate how much I should be saving into a pension per month.

‘How much should a 42 year old woman be saving per month if she hopes to buy an annuity at 60 and want £15000 per annum index linked for the rest of her life?’

ADRIAN SAYS: This is a question that many people ask throughout the various stages of saving for retirement.  Establishing an exact figure can be made easier with the help of a financial adviser and this figure should be reviewed regularly as you save for retirement. There are several factors that help to determine how much you will need to save and how you should go about saving.

The key elements are

• Annuity rates – It is certain that the rates that would apply for a 60 year old today will not be those that will apply in 18 years time. Over the years a number of things will alter the rates that will ultimately apply to the fund you build up, but regular checks of current annuity rates will at least enable you to work to a target capital pension saving.
• Investment Returns – The returns you receive on the underlying investment of your contributions will vary over that period of time and in part, will depend on you attitude to risk – essentially investment gains and losses - and how you build your portfolio. The rate of return you assume should broadly reflect your attitude to risk.

As the rates of return will never run in a straight line regular reviews of performance achieved will assess the suitability of continuing with a previous investment strategy.  These reviews may also highlight changes you need to how much you’re saving.

• Product cost – Different levels of charge will apply to different personal pension schemes and these will impact the eventual fund your investment would produce.

Based on the current annuity tables available from the Financial Services Authority website you would need around £480,000 in your pension fund at 60 to purchase a single life annuity of £15000 increasing by RPI with five year guarantee period for the annuity.

As a guideline, using Skandia’s standard personal pension and assuming a 5% gross investment return with the contributions invested in our Balanced Managed Pension fund you would need to pay a level monthly contribution of £ 1512   to build a fund of £480000 by age 60 if you were to start saving for the first time at the age of 42. 

Taking tax-free cash

‘Aged over 55, I am aware it is possible to withdraw up to 25% tax-free cash from a company pension scheme. However, if I do so, does this require the pension to be 'vested', presumably meaning the remaining fund value will not change/potentially increase from that point. In an ideal world, I might wish to take some cash, but then leave the fund exposed to the markets before later moving it to a SIPP.

‘As a complication, I have 2 pensions - a deferred final salary pension, and a money purchase based company pension into which I am still contributing. Can you clarify the rules and constraints within both scenarios please?’

ADRIAN SAYS: You are right that given you are over the normal minimum pension age you can withdraw up to 25% of the value of company pension as tax-free cash.  This is provided the value of your overall benefits does not exceed the lifetime allowance which is currently £1.8m.

Your question indicates that you want the balance of your pension savings, after taking tax-free cash, to remain invested before moving the funds into a Self-Invested Personal Pension (SIPP) later.

Based on the make up of your pension arrangements there are some issues you should be made aware of: 

Deferred Final Salary Pension

You can take tax-free cash from the final salary pension.  However, final salary schemes do not allow you to remain invested in the markets and transfer the balance to a SIPP later. 

The final salary scheme will provide you with a guaranteed income.  This income will depend on the structure of your final salary scheme benefits.

To provide the flexibility you require you would need to transfer the cash equivalent value of your final salary pension into a money purchase pension.  You can take the tax free cash and move the balance of the fund into an income withdrawal pension, to enable you to keep investment control.  This can be done either through a SIPP or other types of registered personal pension scheme.

I recommend that you seek independent financial advice to determine whether transferring the value of your final salary scheme benefits is appropriate to your overall retirement requirements.  This is because by transferring a final salary scheme, you would be giving up a guaranteed level of income.

Money Purchase Company Pension

I note that you are still contributing into this arrangement.  As this is a company pension and not a personal pension, the scheme rules may restrict the age at which you can draw benefits from the scheme, whilst continuing to contribute.

You should consult your employer about this.

If the scheme rules are flexible you may be able to draw the tax-free lump sum entitlement that you have accrued to date.  However, the company pension scheme may not offer an income withdrawal facility to provide income from the balance of your fund.  If it does not you may need to transfer the value of your existing fund into a personal pension to gain the flexibility you need for income.  However, you should ask your employer if they will allow any such transfer to be taken, while allowing future contributions to build up a fund with the scheme.

Inflation and pensions

‘When I retired from the police service my decision to forego commutation was based on the expectation that my pension would be linked to the RPI. Can the Government now 'move the goalposts' and retrospectively impose CPI linking on those already in receipt of a pension?

‘Despite the pension scheme's description as unfunded (which simply means my 11% contributions were spent and not invested by the Government), I paid handsomely into this scheme. If my 'annuity'(?) is to be interfered with, would I be entitled to revisit my decision about commutation?’

ADRIAN SAYS: Regardless of the outcome of the Government’s ongoing Hutton review of public sector pensions, where decisions have already been taken on the format of retirement benefits, the scheme cannot enable you to revisit your earlier decisions on commutation of pension rights.

To change the basis of future increases in pension in payment from RPI to CPI will require changes to primary legislation and it might be that the changes announced may not ultimately impact people who are already receiving a pension from the scheme.

Pensions abroad

‘I will move back to Germany when I retire in September 2010. My pension fund is worth in excess of £1.3 Million and I would like to transfer it to an approved QROPS -provider as this saves me from UK tax which is higher than the tax in Germany. Based on my own research I want my QROPS be based on Guernsey. Can you recommend a provider which has a good reputation and which accepts me as a customer without going through a financial advisor (which I don't need and don't want to pay excessive fees).’

ADRIAN SAYS: HM Revenue & Customs provides a comprehensive list of QROPS providers who are prepared to have their scheme details published via their website: http://www.hmrc.gov.uk/pensionschemes/qrops.pdf.

The website provides an extensive list of QROPS schemes registered in Guernsey but doesn’t clearly indicate which will deal with clients directly without the help of a financial adviser.  However I do suggest that you seek financial advice.  QROPS can be a flexible and suitable product for some, but as with any financial product there are some restrictions that apply and an adviser can help you shop around for a suitable product and explain all of the small print.  However if you choose not to seek financial advice, I suggest that you discuss your situation with a number of providers so that you can select a provider that you find most suited to your needs.

Once only lump sum

‘I am now 56 and considering options to raise cash for a house purchase [cash payment] - I currently pay £500.00 per calendar month into my SIPP and plan to continue doing so. If I take the 25% capital allowance does that remove my option to take a further allowance on future contributions? i.e is it a once only allowance? Also does this make my pension 'live' in terms of it being transferred to my wife in event of my death and would this affect any tax she may have to pay on it?’

ADRIAN SAYS: Currently each person is entitled to take a tax-free cash lump sum of 25% of the current value built up from the ongoing contributions of their pension fund.  Once this amount is taken, you can then continue to save into your pension and take another 25% tax-free cash lump sum on any new money saved into the pension provided that in total the lump sum you take does not exceed 25% of the Lifetime Allowance of currently £1.8 million.  You will need to check with your SIPP provider to determine exactly how this can be done.

If you do take the pension commencement lump sum of 25% the remaining money in your pension will then be earmarked as future income in retirement.

If you take tax-free cash and die before the age of 77 or before purchasing a lifetime annuity any lump sum paid to your wife on your death will be subject to a 35% tax charge. The fund built up from any contributions you make after taking the 25% tax-free cash lump sum would not be subject to this tax charge.   

New pension income rules

‘What, if any, are the tax implications of the revision to the annuity purchase rules set out in the latest budget? Are there any modifications to the iniquitous residual rates of taxation which recently applied if you vested an ASP?’

ADRIAN SAYS: Following the budget announcement the Government will consult on making changes to the current ASP rules.  People already in ASP on the 22 June 2010 will remain unaffected through the consultation process. We believe the Government will publish its consultation document in late July.

People who reach age 75 on or after 22 June 2010 will continue to draw their benefits at age 75 and will receive any relevant tax free cash entitlement. They will also be able to use the pre-75 income withdrawal rules throughout this transitional period up to their 77^th birthday. This will not only allow more flexibility of income in that period but will also ensure that if death occurs then any lump sum will be subject to a 35% withholding tax charge and there will be no Inheritance Tax liability assessed against the estate in respect of that payment

I would expect any change to the current ASP system that results from the review to apply to both those already in ASP and to those who may fall into the transitional rules announced in the recent Budget

Tax free allowance

‘I have a private pension which is taxed at source so the full allowance is taken from this pension. How will this work when I reach state pension age, will the Inland Revenue take this into account?’

ADRIAN SAYS: Each person has an individual a personal allowance which is in effect a tax-free allowance. Pension income, whether from private or State pensions will be set against that allowance.

The State Pension is received gross so you are likely to see the net amount of your private pension reduce because the State Pension will be the first pension to be set against your personal allowance. You will receive a tax coding from time to time from your Local Inspector of Taxes that reflects the projected level of tax that should be recovered from income payments you receive from Non-State pension sources. The coding will be sent to your private pension provider to enable adjustments to be made, whenever applicable, to the tax deducted from the gross pension payable.

Protected rights

‘Part of the monies I transferred into a SIPP had protected rights. This represented approx 26% of the total value transferred.

I understand that it is a requirement of the protected rights that should I purchase an annuity I would have to ensure that this provided a 50% widows pension. Since the monies are now invested and the total fund value will change how will the issue of protected rights be dealt with should I decide to buy an annuity at a later date?‘

ADRIAN SAYS: You will only be required to purchase an annuity with a 50% widows pension should you have a surviving spouse at the time you elect to buy the annuity. Any pension provider must be able to separately identify the value of the Protected Rights and Non-Protected Rights within a member’s account. This is because the purchase of income in the form of annuity or in dealing with the different ways in which any lump sum death benefits may need to be paid.

The government has confirmed that, in April 2012, Protected Rights will cease to exist so that the whole value of your pension fund will be treated as Non-Protected Rights. This should remove the need to buy a widow’s pension when you buy an annuity after that date.

A SIPP to manage investments

‘My wife was made redundant, shortly before the age of 60, and now has had her Company pension turned into a Personal Pension Plan. She wishes to keep her options open with this element of pension.

We have considered matters, and are wondering whether to turn it into a SIPP, or something similar.

We wish to operate this fund to bring in not only dividend income, but to be able to operate a limit buy and sell mechanism, just to ensure there would not be a violent loss as for example with BP.

Is a SIPP the most tax efficient vehicle, and who operates such a mechanism.

Alternatively should we be considering other methods / mechanisms for maximising regular income, future pension benefits??’

ADRIAN SAYS: It seems you are thinking of personally managing a share portfolio inside of the personal pension scheme. A SIPP wrapper would deliver this type of investment management structure which would not be available through most standard personal pension arrangements. Similar flexibility exists through the use of personal pensions that offer a Private Managed Fund facility. It would then be a matter of looking at the underlying costs of each route as suited by your personal requirements.

A further alternative would be use collective investment funds where you select fund managers to manage monies on your behalf. They will be using their expertise to determine when to buy and sell stocks for delivering longer term value.

The vast majority of personal pension schemes now offer a wide range of investment funds and investment trusts with which you can use to build a portfolio suited to your attitude to gain and loss and your needs.  Normally these have switching facilities that enable you to change your strategy quickly and normally with little cost.

Within a SIPP you can hold both individual shares, and investment funds but you need to consider the costs involved of each option in delivering the planning that you and your wife wish to receive. As a general rule of thumb, a SIPP is probably only the right level of sophistication if you intend to hold individual shares, or transfer existing share holdings into your pension. For the majority of people, a personal pension with access to a large range of investment funds will more than adequately satisfy their investment choices.

Rules for high earners

‘I earn just over £130k and will be impacted by the anti-forestalling rules for pensions. This limits me to £20k at full tax relief. Anything above will be limited to 20% relief (assuming I have understood all the rules) However because I earn over £100k I will also lose my personal allowance. Now if I pay £30k to my pension will I get my personal allowance back. While the additional £10k will only attract 20% tax relief it will potentially deliver my £6k personal allowances back. Is this correct?’

ADRIAN SAYS: The good news is that you may not be subject to the anti-forestalling rules at all. If your relevant annual income which will include dividend income and interest on savings is only just over £130K then you are able to deduct from that the first £20,000 gross of personal relievable contributions that you make to a registered pension scheme.

If that takes your relevant income below the £130,000 threshold for the current tax year and the two previous tax years then you will not be subject to the anti-forestalling rules and the contribution you are anticipating making make will receive higher rate tax relief and will bring back to you the full personal allowance.

Even if you are subject to the anti-forestalling provisions the payment of the additional contribution required to take you below the £100,000 threshold will deliver the full personal allowance back to you.

Have a word with a financial adviser who can provide financial advice tailored to your exact income and needs.