Introduction

Proposals for the radical simplification of the taxation of pensions were originally announced in December 2002 and initially intended to take effect from April 2004. Following representations from the pensions industry, the start date has now been delayed until April 2006 (referred to as 'A-day').

In this bulletin we focus on the way in which the new regime will operate to allow tax relief on contributions into a pension fund and how monies can be extracted in retirement. Although the new regime is a simplification this does not mean that pensions will become simple! Some reference is required to the terminology used in pension provision and a glossary of the terms is included with this bulletin.

The plan is to scrap the existing eight tax regimes for pensions and replace them with a single set of rules. Currently there are anomalies between the different types of schemes.

For example, under a modern defined benefit scheme, employees may contribute, with tax relief, up to 15% of earnings up to the earnings cap (£105,600 for 2005/06). Under a modern personal pension plan, individuals may receive tax relief on contributions up to the higher of £3,600 a year or a percentage of capped earnings, the percentage varying according to age.

Furthermore the regimes have different rules regarding what benefits can be paid out to members. Members in a modern defined benefit scheme are limited to two thirds of final earnings (up to the cap) after 20 years' service but there are no limits on the size of pension benefits for those with personal pensions. There are also different rules governing the amount of tax-free lump sums that different schemes can pay.