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A completely new set of tax rules for pension plans, and for contributions
to pension
plans, comes into effect on 6 April 2006. Overall, the new regime will
be simpler and
will offer more choices for pension savers, but there are still some points
to watch.
One widely-publicised change is that it will be possible for an individual
to purchase a
buy-to-let property within his or her personal pension scheme. This has
been advertised
as an opportunity to buy a house or flat at a 40% discount - on the basis
that money paid
into the pension scheme to fund the purchase will qualify for tax relief.
Also, rental
income and capital growth both qualify for tax exemption within the pension
fund. The
downside is, of course, that the money may only be withdrawn as retirement
benefits in
accordance with the usual rules for pension schemes.
There will also be an immediate practical difficulty in that, under the
new tax rules, a
pension scheme will not be able to borrow more than 50% of its nett value.
Thus if the
pension fund consists of a cash deposit of £ 100,000, the scheme
could only borrow a
further £50,000, making its maximum purchase a house or flat worth
£150,000. Buying
the same property by putting £15,000 into a new pension scheme and
taking out a 90%
mortgage will not be an option.
Again, in theory it will be possible to buy an overseas holiday home within
a personal
pension scheme - but here there will be even more problems. Firstly, a
tax charge will
arise if the family uses the property without paying a full market rent.
More importantly,
the taxes levied by the country in which the property is situated must
be considered. As a
general rule, it will be necessary to purchase the property within a company,
because
most European countries do not recognise a personal pension scheme as
a legal entity ,
and that company will be subject to local taxes on its income and capital
gains. Even if
the pension plan holder still wished to proceed on that basis, it might
be difficult to show
that the purchase was a suitable investment for the pension fund, given
the potential
overseas tax liabilities.
Action before 'A'- Day
The date the new tax regime for pension funds takes effect - 6 Apri12006
- has been
dubbed 'A'- Day. Although the new rules are generally more favourable
to the pension
saver, in some cases an advantage can be gained by taking action before
'A'- Day. In
particular :-
* Under the new regime it will not be possible, as it has been in previous
years, to claim
tax relief for a pension contribution in the year before it was paid (usually
referred to
as 'relating back'). Accordingly, anyone who wants to take the tax relief
in 2005/06 -
for example, because he has an exceptionally high income this year - needs
to make
the contribution by 5 April 2006.
.
* When a pension saver has accrued benefits under a Retirement Annuity
Contract
originally taken out before July 1988, it is possible that he will be
able to take a
greater proportion of his total pension fund as a tax-free lump sum if
he begins to
draw his pension before 'A'- Day. This is particularly likely if the RAC
offers a
relatively high Guaranteed Annuity Rate. It is not usually possible to
begin drawing a
pension under a RAC before age 60.
* At present, it is possible to base pension contributions on the highest
earnings in the
last five tax years - thus it is even possible to pay substantial pension
contributions
after retirement. But from 6 April 2006 post-retirement pension contributions
will be
limited to £3,600 a year.
* If contributions made after 5 April 2006 take an individual's total
pension savings
over £1.5 million, the usual pension fund tax exemptions on the
excess will be
clawed back. Therefore, if anyone wants - and is able - to put more than
£1.5 million
into their pension fund, they should do so before 'A'-Day. However, this
is not likely
to affect many people!
* It is currently possible for the proprietors of a business to arrange
for their pension
fund to buy commercial property, such as a small office building, and
then let it to
their business. This will remain possible under the new regime but the
maximum
loan that the pension fund can take to help finance the purchase will
reduce, from one
equal to 75% of the cost of the building to one equal to 50% of the nett
value of the
pension fund (the same rule as for buy-to-lets). Thus a pension fund worth
£200,000
could currently buy a commercial building for £800,000, but after
'A'- Day could
only afford one worth £300,000.
Wait until after 'A'- Day
On the other hand, there will be situations where it will pay to wait
until after 'A'.
Day. For example:-
* If benefits begin to be taken from a Free-Standing Additional Voluntary
Contribution
(FSAVC) Scheme before 'A'- Day, they must be taken wholly in the form
of a
(taxable) pension. After 'A'- Day, 25% of the fund may be taken as a tax-free
lump
sum. FSAVCs are sometimes used as a 'top up' pension for an employee or
director
who is also a member of a company pension scheme.
* After 'A'- Day it will be possible for an individual, aged 50 or more,
to make a
substantial contribution to a pension plan and then immediately withdraw
25% of
that contribution as a (tax-free) lump sum, leaving the remaining 75%
to accumulate
to produce a pension at a later date. For example, if a higher rate taxpayer
contributed
£20,000, the nett cost of a pension fund worth £15,000 would
be only £7,000 (after
40% tax relief- £8,000 -and a £5,000 lump sum) - though this
simple example does
ignore the effect of the pension company's charges.
If you feel you may have a problem with this issue and wish to discuss
it call
Stuart Atkinson on 01482 226791
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