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Pensions can be a complex subject and only the main types and rules for private (non-State) schemes are covered here. SCHEME TYPES     ...The Main Types of Schemes STAKEHOLDER PENSIONS     ...Employers     ...Tax Relief     ...Charges CURRENT RULES     ...Who is Affected?     ...Investment Limits & Tax Relief     ...Lifetime Allowance     ...Retirement Age     ...Cash Lump Sum     ...The Pension Income     ...Death Benefits OPTIONS AT RETIREMENT     ...Options for the Income     ...General Options   TYPES OF PENSION SCHEMES There are several types of private pension schemes. The main ones are as follows.   OCCUPATIONAL PENSION SCHEME (OPS): Provided by an employer. Employees might have to contribute. The pension income will be based on either: (i) whatever the fund is worth ('Money Purchase' or 'Defined Contribution') or (ii) final salary and the number of years of service with the employer ('Final Salary' or 'Defined Benefit'). There might be a death-in-service lump sum and dependants' pensions.   ADDITIONAL VOLUNTARY CONTRIBUTION (AVC): Accompanies an OPS for extra contributions you might make. Managed by either the main scheme (an 'In-House AVC') or by a pension company of your choice (a 'Free-Standing AVC [FSAVC]').   RETIREMENT ANNUITY CONTRACT (RAC): No longer available (but contributions may still be made into an RAC by anyone who has one if still eligible to contribute). RACs were for people earning but not in an OPS. The pension income will be based on whatever the fund is worth ('Money Purchase'). An RAC is owned by you (not by any employer).   PERSONAL PENSION SCHEME (PPS): For people who earn but who are not in an OPS. A PPS is owned by you (not by any employer). There may be life cover as well as pension investment. The pension income will be based on whatever the fund is worth ('Money Purchase'). Nowadays, new schemes are likely to be 'Stakeholders' instead.   STAKEHOLDER PENSION (SHP): A flexible, low-charging individual scheme. See the Stakeholder section (below) for more details.   SECTION 32 BUY-OUT (S32): Holds a transfer value taken from an OPS, where the employee has left that employer and wishes to have personal control over the fund.   SMALL SELF-ADMINISTERED SCHEME (SSAS): A type of OPS allowing company directors to set up a tailored pension scheme for themselves. The above is only a basic outline of the main types. <Top of Page> STAKEHOLDER PENSIONS A Stakeholder Pension is a flexible, personally-owned, low-charge pension scheme. If you are UK resident, you're probably eligible to have one. You can be employed, Self-Employed, working but unpaid, or even not working. There is no minimum age - so even children can have Stakeholder pension plans. Grandparents, parents, guardians, etc. can invest into one for a child. Employers Most employers with at least 5 staff on the payroll must offer access to a Stakeholder scheme to their staff ... unless eligible for exemption (e.g. because there's a good pension scheme already in place). Tax Relief Individuals invest net of Basic Rate Tax relief. The pension scheme collects this tax relief from the State. So: for each £1,000 invested, an individual need only write a cheque / sign a direct debit for £800. Higher Rate taxpayers can claim extra tax relief via the annual Tax Return. Additional Rate taxpayers can claim extra tax relief via the annual Tax Return, but the rate of tax relief reduces by 1% per £1,000 of gross income in excess of the Higher Rate Tax ceiling, down to a mimimum level of tax relief at Basic Rate). As with virtually all pension schemes, the fund is allowed to grow in a tax-efficient environment. At retirement, up to 25% of the fund may be withdrawn as a cash lump sum, usually free of tax. Pension income is taxable (as earned income). Charges / Running Costs Stakeholder pensions have their administration charge capped at a very low level. The maximum is just 1.5% p.a. for the first 10 years, after which it's just 1% p.a. NB: The maximum charge does not necessarily cover the cost of any research and advice. <Top of Page> CURRENT RULES Who is affected? On 6 April 2006 (known as 'A Day'), there were major changes to the rules regarding how much can be invested into pensions, tax relief, etc. There were subsequently some rule changes, and a fairly major revision to the rules effective from 6 April 2011. People affected by the rules are UK resident and could be employed, Self-Employed, working but unpaid, or even not working. Investment Limits For individuals, the maximum allowed size of investment for tax-relief purposes is £3,600 p.a. ... or ... 100% of earnings (up to a limit) if higher. The £3,600 figure applies even if you have no earnings. For an employer, there is no limit set for the amount which can be contributed: it's up to the local Tax Office to decide on the amount of tax relief available. Mind you, there is an 'Annual Allowance' . . . Annual Allowances & Tax Relief There is an overall Annual Allowance which is a maximum for total tax-relievable pension contributions. It's as follows:         £215,000 in 2006-07         £225,000 in 2007-08         £235,000 in 2008-09         £245,000 in 2009-10         £50,000 in 2010-11 *         £50,000 in 2011-12         £50,000 in 2012-13         £50,000 in 2013-14         £50,000 in 2014-15         £50,000 in 2015-16         with reviews thereafter. * It was announced in October 2010 that the Annual Allowance was being drastically reduced (from £255,000) BUT that it is now possible to carry-forward unused Annual Allowance for up to 3 years. Contributions in excess of the Allowance would be subject to a tax charge (at 50% since April 2010), levied on the individual. For final salary ('defined benefit') schemes, the Annual Allowance is based on the increase in value of the benefit: £16 for each extra £1 p.a. of pension benefit. Payments which do NOT count towards the Annual Allowance are: a contribution from an individual in excess of 100% of earnings (because no tax relief would be given) (a pension provider might not accept such a contribution, mind you) age-related National Insurance rebates to contracted out money-purchase schemes a transfer between registered schemes some pension credits granted on divorce contributions into a non-registered scheme Individuals invest net of Basic Rate Tax relief. The pension company collects this relief from the State. So for each £1,000 invested, an individual pays only £800. The £3,600 p.a. figure mentioned above is gross. The net-of-Basic-Rate-Tax-relief amount payable is currently £2,880 p.a. / £240 p.m. Higher Rate taxpayers can claim extra tax relief via the annual Tax Return. Additional Rate taxpayers can claim extra tax relief via the annual Tax Return, but the rate of tax relief reduces by 1% per £1,000 of gross income in excess of the Higher Rate Tax ceiling, down to a mimimum level of tax relief at Basic Rate). Funds invested into registered schemes are allowed to grow in a tax-efficient environment. Lifetime Allowance There is a Lifetime Allowance, which is a per-person maximum permitted tax-efficient pension fund size. It includes contracted out benefits. It's as follows:         £1.50 million in 2006-07         £1.60 million in 2007-08         £1.65 million in 2008-09         £1.75 million in 2009-10         £1.80 million in 2010-11         £1.80 million in 2011-12         £1.50 million in 2012-13         £1.50 million in 2013-14         £1.50 million in 2014-15         £1.50 million in 2015-16         with reviews thereafter. Any excess funds when a benefit is taken (a 'benefit crystallation event') are subject to a 'recovery charge' tax levy. For final salary ('defined benefit') schemes, the Lifetime Allowance refers to a 'fund equivalent value' of 20 X the annual income. Existing pension income from an approved scheme, where the pension income commenced prior to 06/04/2006, is valued when a subsequent pension benefit comes into payment. The 'fund equivalent value' is 25 X the annual pension income. * * Income Withdrawal (or 'Drawdown') arrangements will apply this factor to the maximum income available. Existing pension income from an approved scheme, where the income commenced after 05/04/2006, is valued using a factor of 20 X annual pension income. This assumes that the income increases by no more than the greater of 5% p.a. and inflation. A larger increase would be treated as a 'benefit crystallation event' and be valued at 20 X the annual amount. People who as at 06/04/2006 had pension funds of approaching £1.5 million or more had (until 05/04/2009) two options to try to protect their funds from the recovery charge levy. These options were 'Primary Protection' and 'Enhanced Protection', but are not covered in detail here. Retirement Age The minimum allowable pension age for registered schemes increased on 06/04/2010 from 50 to 55. There are rules (not covered here) for people in certain occupations, such as sportsmen, police, etc. People in serious ill-health may take benefits early. Prior to the Budget on 22/06/2010, the maximum pension age was 75. However, the government has now abolished the obligation to 'annuitise' prior to reaching the age of 75. Pension income may be delivered after age 75 through 'Income Drawdown' (see below). Cash Lump Sum ALL schemes now allow members to take up to 25% of the fund (up to the Lifetime Allowance limit) as a tax-free cash sum. Lump sums taken from funds exceeding the Lifetime Allowance are subject to tax at 55%. Some pre-06/04/2006 schemes can offer more than 25% as tax-free cash. In general, this is protected - but a transfer out could cause the right to be lost. The Pension Income The remaining pension fund (or all of it if no cash sum is taken) is used as follows... ...to buy a 'secured' pension: (a guaranteed lifetime annuity income or scheme pension); or ...put into an 'Income Drawdown' arrangement: (see below). Income Drawdown: The pension fund remains invested. An income can be drawn, if required. NB: If you take the maximum allowed pension income early on, then your might face a drop in income at a later age. Death benfits after age 75 can suffer from a tax charge. Death Benefits On death prior to 'vesting' (converting a pension fund into an annuity) prior to age 75, uncrystallised pension benefits (up to the individual's Lifetime Allowance) can be paid out tax-free as a lump sum. The individual's Lifetime Allowance would be reduced by the value of any prior crystallisation events. Any lump sum death benefit in excess of the Lifetime Allowance would be taxed at 55%. A lump sum death benefit from an Income Drawdown arrangement is subject to a tax charge, whether before or after age 75. A lump sum death benefit from age 75 onwards is subject to a tax charge. <Top of Page> PENSION OPTIONS AT RETIREMENT Options for the Income The structure of your private pension income can depend on the type of pension scheme(s) you have. Converting a pension fund into an annuity (a pension income for life) is known as 'vesting'. There are several styles for how your annuity might be paid. These must be arranged PRIOR to vesting. Here are some examples: Increases: The income could be non-increasing ... or escalate at say 3% p.a. / 5% p.a. / inflation-proofed. Some schemes have 'Limited Price Indexation' (LPI), meaning that they are inflation-proofed up to 5% p.a. Alternatively, there are some annuities where the income varies (down as well as up) because it's based on the value of an underlying fund. Spouse's Benefit: Your widow(er) could have no benefit, half, 2/3rds or all of your pension: payable for his / her lifetime after you have died. Frequency of Payments: The income could be paid monthly, quarterly, half-yearly or yearly. Guaranteed Period: A minimum number of initial years (e.g. 5 or 10) during which the income will continue (to your partner / estate), if you were to die during this period. Lump Sum Payment: All schemes now allow you to take part of the fund as a cash sum. The remaining fund being used to provide your annuity / income. NB: with most types of pension scheme, the amount of pension income you'll start off with depends on the size of your fund. Some of the above options will reduce the size of pension income you receive, at least to start off with. At retirement, you need to consider the longer-term need for income for yourself and partner (if any), as well as your immediate need for income. General Options Using The Existing Provider: Accepting the annuity offered by the existing pension scheme provider. Whilst this may not give you the highest income, it requires only a minimum of effort / paperwork. Shop Around: An IFA can transfer your fund (using the 'Open Market Option') to an alternative annuity provider. This could get you a higher guaranteed income and/or the style of benefits you desire. Ill-Health & Enhanced Annuities: If you (and/or spouse) smoke or are overweight or have a medical condition which might shorten some people's life-expectancy, then some annuity providers would pay a higher pension income to you. You may need to shop around (see above) to achieve this. Deferred Vesting: Starting part or all of your pension income at a later date. Even without any growth in value of the fund and all else being equal ... the older you are when you vest a pension then the higher the income should be. (Because our remaining life expectancy is shorter the older we are). NB: it's possible that the fund might not grow in value, and/or that the annuity rates might not be as good at a later date.   For the following alternative retirement options advice, we act as introducers only . . . Phased / Staggered Vesting: It may be possible to split your fund into a number of 'mini plans' and vest them individually over a number of years. (Or if you already have several pension plans, vest a couple when you retire ... others later on ... until they're all vested). The potential benefit is that the older you are when a portion is vested, the higher the income should be from that portion. NB: the funds might not grow, and/or future annuity rates might not be as good. Income Drawdown: Provides income from the fund which continues to remain invested. (see the Current Rules section, above). But NB: the balance of your fund might not grow sufficiently well ... and/or interest rates might fall ... so the size of future income could fall. Also, if your pension funds total less than £100,000, then this route may not be for you, because smaller funds are more vulnerable to adverse performance and plan charges. <Top of Page> FURTHER INFORMATION Please contact us [opens a new window] if you would like further information. Levels of and bases of and reliefs from taxation are subject to change.   <Top of Page> The editorial here does not constitute personal advice. It reflects Bernas Coni Warren's understanding of current law and tax practice, and is without prejudice. No liability shall attach. Errors & Omissions Excepted.   © Copyright Bernas Coni Warren www.BernasConiWarren.com 01275 83 73 03 7 School Close, Whitchurch, Bristol, BS14 0DU Bernas Coni Warren is an appointed representative of Sesame Ltd, which is authorised and regulated by the Financial Services Authority. Sesame is entered on the FSA Register under reference 150427.