Public and private pensions: Your questions answered

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Pensioners demonstrate outside the Conservative Party Conference on October 5, 2010 in Birmingham, England.
Image caption,
Pensioners protest against the loss of their pensions at this year's Tory Party conference

Big changes have been proposed to the UK's pension system in the past few months.

We asked you to send in your questions for Malcolm Mclean of the actuarial firm Barnett Waddingham to answer.

Last week he dealt with your questions about the government's plans for the state pension, mainly the raising of the state pension age to 66.

This week he tackles your questions about the private and public sector pension systems.

The government will doubtless try to ensure that the legal framework for the changes is watertight and not successfully challenged on the basis of, for example, what might be construed as "deprivation of past accrued rights".

For public sector pensions, the changeover to CPI instead of RPI is planned to take effect from next April and will result in smaller increases than might otherwise have applied - September's RPI rate was 4.6% while CPI was 3.1% - although it should be emphasised that this may not always be the case in future years.

The situation is somewhat more complicated for private sector pensions which have their own scheme rules that sometimes bind them into using the RPI.

Any legislation in this instance may well be overriding of individual scheme rules in indicating that CPI is normally the appropriate yardstick for determining pension increases.

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There is more pension legislation to come, warns Malcolm Mclean

But it is possible that it could leave an option for schemes to use a higher measure of inflation if they so choose.

We will probably have to await sight of the detailed legislation to appreciate the full impact on and options for private sector schemes.

(Updated answer 21 December, 2010) The government has now announced that the new legislation will not be overriding of individual scheme rules.

This means that, dependent on the precise wording of the rules, some private sector schemes will have no option but to continue to allow inflation increases on the basis of the RPI whilst others will remain with or move to the CPI.

As explained in the answer to the previous question, all public sector schemes are likely to be required to use the CPI as the measure of inflation for next year.

(Updated answer 21 December, 2010) It is still the government's stated intention that all public sector schemes use the CPI as the measure of inflation from April 2011.

At the last Budget, the chancellor announced that the effective requirement to purchase an annuity by age 75 will be scrapped from April 2011.

The age limit was raised to 77 in the meantime as a stop-gap.

Subject to the outcome of a public consultation (details of which have yet to be announced) we expect legislation will be amended so that:

  • There will be no specific upper age limit for buying an annuity, so you can delay doing so for as long as you like
  • You will be able to set up a "capped drawdown" arrangement under which you will be able to take a regular income from your pension pot. This will be subject to a cap on the annual amount that can be withdrawn (similar to the arrangements currently in force for a person under 77)
  • Alternatively if you can demonstrate that you have sufficient regular income from other sources to ensure that you will never need to fall back on the state and claim means-tested benefits, then there will be no upper limit on how much you can withdraw from your pot in any given year, under what will be termed a "flexible drawdown" arrangement
  • Inheritance tax will not apply to funds passed on to beneficiaries after your death, although there will still be tax charges to claw back some of the tax-relief you have received on paying in the pension contributions.

We are also expecting the government to remove the age 75 limit on taking a tax-free lump sum.

(Updated answer 21 December, 2010) The government has now confirmed that the upper age limit for buying an annuity will be scrapped from April 2011 and that the level of regular annual income required for flexible drawdown will be £20,000 (from the state pension, occupational pensions in payment and pension annuities).

The report from the commission set up to review public service pensions chaired by the former Labour minister, Lord Hutton, was an interim report.

A final report will be made in the spring of next year in time for government announcements to be made on it in the 2011 Budget.

The final report is expected to confirm Lord Hutton's initial findings in favour of replacing the current final-salary defined benefit schemes with some kind of career average earnings alternative and with later retirement ages.

There will also be a requirement for higher employee contributions in all but the armed forces scheme, although it is likely that low paid workers elsewhere will also be protected from such increases.

At present, when you begin to draw pension from an occupational pension scheme or a personal pension, you can normally take up to a quarter of the value of the benefits as a tax free lump sum, known officially now as the Pension Commencement Lump Sum (PCLS).

Rumours that this long-standing "perk" will be scrapped have been doing the rounds for many years and there is always the possibility in a worsening economic climate that could yet happen.

But to the best of my knowledge, the government has no plans currently to do away with the tax-free lump sum.

Indeed the Liberal Democrats made a specific promise before the election that they would not scrap it.

That reiterated the sentiments of the current pensions minister, Steve Webb, when in opposition back in 2002 he described any proposal to do so as "sheer madness".

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Pensioners often have to run hard to stand still financially

In normal circumstances the state pension is included with other taxable income such as earnings or private pension payments.

Tax is charged at the appropriate rate on any part of the aggregate income which exceeds your personal tax allowance in any particular year.

Special arrangements do apply, however, in the way tax is charged, or not charged, on the cash lump sum derived from deferring taking a state pension for a minimum period of 12 months.

Quite simply, if you are already paying tax you will pay tax on this cash lump sum at the same rate as you are paying on your other income (e.g. 20%) and it will not affect any age-related allowances you may be receiving.

If your other income is not high enough to require you to pay tax on that income, and you are therefore a non-taxpayer, then you will not have to pay any tax on the lump sum either.

It had originally been decided by the previous government in their last budget that all personal tax allowances for 2011-12 would be frozen at their 2010-11 levels.

In other words at £6,475 for individuals aged under 65; at £9,490 for those aged between 65 and 74 and at £9,640 for those aged 75 and over.

Subsequently the new coalition government announced that the personal tax allowance for the under 65s would be increased for 2011-12 by an additional £1,000 bringing it up to £7,475.

But it gave no indication that it planned to increase the other older age allowances in any similar way.

It also made no change to the planned reduction of all personal tax allowances for higher earners by £1 for every £2 they earn above £100,000 regardless of age.

Unless or until, therefore, some further concessions are made by the government, the higher age personal allowances will remain frozen at their present levels and this may have, for some people, the impact Mary has described.

For those older individuals who do not receive the higher age allowance on income grounds they will, of course, benefit along with the under 65s from the £1,000 increase to the basic allowance.

(Updated answer 21 December, 2010) The government has now announced that the higher age personal tax allowances will in fact rise from April 2011 - for age 65 to 74 from £9,490 to £9,940 and for age 75 or over from £9,690 to £10,090.

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Big changes are in the offing for state, public and private pensions

Assuming your salary sacrifice arrangement with your employer has been set up properly, and meets certain conditions required by HM Revenue and Customs, you will not be considered a higher rate taxpayer for the current 2010-11 tax year if your taxable earnings added to any other taxable income you may have do not exceed £37,400.

A salary sacrifice happens when an employee gives up the right to receive part of the cash pay due under his or her contract of employment.

In this case, the sacrifice is made in return for the employer's agreement to provide additional non-cash benefits in the form of pension scheme contributions.

Salary sacrifice can lead to tax and national insurance savings for both employer and employee and can, and often does, encourage pension saving into an occupational scheme.

Hopefully reasonably substantial widows pensions will be paid by both the company scheme and the state in the event of you predeceasing your wife.

The level of pension awarded to the widow from the company scheme will depend on the rules of the scheme but would normally be at least half the rate of the pension paid to the member.

If precise details cannot be located in any paperwork held, the scheme administrator should be contacted and asked for confirmation of the rules and what level of provision is likely to be made.

With regard to the state pension, on your death your wife's existing pension of £58.50 a week will be upgraded to the full rate basic pension of £97.65 previously included within your pension.

It is also probable that she will inherit the whole (100%) of your additional SERPS pension of £89.65 a week (£187.30 less £97.65).

That is on the presumption that you had reached your state pension age of 65 before 6 October 2002.

At that date the maximum percentage of inherited SERPS payable was reduced to 90%, and then subsequently in stages, with further 10% reductions to its present intended permanent level of 50% from 6 October this year.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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