Those leaving it late to fund pensions could be hit twice by the new rules

If you have not already read my post The pension tax relief changes explained and who they affect then now is as good a time as any to do so.

But moving on from this there are a couple of points hidden away in the proposals which I wanted to bring to light. While they may not be getting many headlines one of them has important consequences for those who have left it late to fund their retirement, or indeed those who plan to.

The small print:

• The new annual allowance test will not be applied in the year of death, or in the case of lump sums paid where individuals are diagnosed with ‘major’ ill-health.
• Currently the annual allowance does not apply in the year of retirement. Not a lot of people know this but it has been a useful piece of retirement planning for people who are about to retire. In theory they could make large payments into their pension, receive tax relief and then immediately start drawing retirement benefits (including the receipt of a 25% tax-free lump sum). However this “last year” exemption is to be removed, meaning that even those about to retire will be subject to the annual allowance as normal.

So what does that mean?

Well the new rules will be a blow to people who have left retirement planning until very late in their working lives. Not only has the ‘last year rule’ been abolished but they will only be able to save £50,000 per annum into a pension. Now while the number of people affected in this way will be relatively small, especially given that most people do not save in excess of £50,000 into pensions each year, it’s important that people realise that if the new proposals do come in in the announced form then they should think twice before postponing retirement planning.

 Blimey, I earn a £120,000 per annum and am due to retire. I planned to use the ‘last year’ rule to boost my pension fund. Is that it – am I stuck with the £50,000 limit?

 Not necessarily. The proposals suggest that you would be able to carry forward any unused annual allowances from the previous three tax years, meaning a potential extra £150,000 top-up to the normal annual allowance. Obviously if you have already used your £50,000 allowances previously then you will likely be stumped. Obviously the old rules were more generous but there you go.

However, HMRC will publish the draft legislation for review towards the end of 2010. It is planned that this legislation for the above changes will be incorporated into the Finance Bill 2011. So there is still time for any or all of the above to change.