Pension changes: What you need to know

After A-Day, individuals with pension pots of less than £15,000 can take the money as a lump sum rather than converting it into an annuity. However, this rule applies to the totality of the fund. In most cases, the fund will actually exceed £15,000.

The tax-free lump sum you will be able to take at retirement will continue to be 25 per cent after A-Day. For people on a low income who have opted out of the second state pension (now known as S2P), it might be wise to delay retirement until after A-Day so they can take their money as a lump sum.

Retirement age

The earliest age from which you can take an occupational pension or personal will increase from 50 to 55 by 2010.

If your current pension contractually allows you to retire at 50, you will still be able to do so by 2010.

Fund size

Current rules allow you to take a pension two-thirds of your final salary, with a maximum fund size of £70,400. The new lifetime allowance rule scraps this limit.

Lifetime allowance

The complex systems of taxation on contributions and retirement benefit amounts are replaced on April 6 by a single cap, known as the lifetime limit.

The cap is set at £1.5m from 2006, rising to £1.8m by 2010/11. Any assets in your pension fund that exceed the lifetime limit will incur 55 per cent tax - known as the lifetime recovery charge.

What this means in effect is that people with higher-valued retirement plans need to act before A-Day to avoid paying a hefty surcharge on benefits that exceed the £1.5m cap.

If you think the value of your pension benefits is going to exceed the cap, you can act to safeguard your entitlements and avoid the 55 per cent charge by registering for primary or enhanced protection.

Both forms of protection are transitional arrangements designed to protect entitlements built up before 6 April. There isn't a form of protection to protect rights built up from that date.

As a rule of thumb, primary protection is appropriate for those who are expecting unexceptional salary rises and/or investment returns, while enhanced protection will be of most benefit for those who foresee high salary rises and good investment growth.

Primary protection

Registering for primary protection protects the excess value of your pension fund above the £1.5m limit and allows modest growth in line with the lifetime allowance, without triggering the 55 per cent charge. You need to assess the proportion of your fund that exceeds the cap and register it as a percentage.

For example, if your fund is £3m, that is £1.5m (50 per cent ) more than the cap. This means that your fund will be allowed to grow by 50 per cent before the tax charge kicks in.

So in 2010 you will be allowed to have a fund to the value of £3.6m. The tax-free cash entitlement is expressed as a percentage of the value of the fund at A-Day. Primary protection allows the pension holder to accrue further benefits after A-Day, though these will be subject to 55 per cent tax.

Enhanced protection

If your fund is below the £1.5m cap at A-Day, but you expect high salary growth and/or a high return on your fund's investments, you should register for enhanced protection.

This protects the full value of future investment returns and salary growth. However, enhanced protection means you can make no contributions to your fund after A-Day.

It would be a mistake to think only super-wealthy excutives need to worry about taking out enhanced protection.

A small percentage of employees in both the private and public sectors who have racked up decades of service and a pension entitlement of £75,000 a year could find their benefits and investments exceed the cap.

Paul Riddell at pension provider Winterthur Life says: "A-Day is designed to simplify pension arrangements, but inevitably the new rules won't be that simple.

"The majority of people won't be affected by the changes, but if someone feels there is a chance their portfolio will grow to a size where it is exposed to the recovery charge, they should talk to an independent financial adviser immediately. "

Riddell said most advisers use sophisticated calculating software to estimate the future size of an individual's fund - and the potential tax risk to its assets.

He added: "If your fund is £800,000 at the moment and is growing by 5 per cent a year, then by 2010 you will have to pay the lifetime recovery charge. The bottom line is that if you don't register for some form of protection before April 6, you could be hit by a hefty charge in the future. "

How to claim protection

Attubato says: 'To claim protection, an individual must notify the Revenue. 'The notification must be made on the "Protection of Existing Rights" form [NWL] which must reach HMRC on or before 5 April 2009. The form can be completed and sent online, by going to www.hmrc.gov.uk.

Tom McPhail, Head of Pensions resaerch at Hargreaves Lansdown, says: "HMRC has published a draft form on the internet, which can be used to apply for protection. It is hoped that the actual form will be available by A Day.

"The most important consideration is for those who decide to apply for enhanced protection. In order for this protection to apply, they will need to ensure that they make no further pension contributions after A-Day. "

So they will need to notify their pension scheme administrators, cancel direct debits and standing orders, and generally make sure that all their pensions have been mothballed by A-Day.

Income

Income drawdown, which allows pension holders to take income from their fund before retirement and between the ages of 50 and 75, is to be renamed 'unsecured pension'.

The introduction of an entirely new retirement option, the Alternatively Secured Pension, will enable you to defer annuity purchase past the age of 75.

Two new types of annuity - the Limited Period Annuity and the Value Protected Annuity - are to be introduced. The limited annuity allows you to use a part of your pension fund to buy an annuity for a fixed period of five years, while the rest of your fund is invested. After five years you can buy another annuity.

The value protected annuity safeguards your pension income if you die before receiving the full amount. The remainder is paid into the holder's estate and is subject to 35 per cent tax. This option is not available to those over the age of 75. Alternatively you could buy lifetime annuity, as is the case at present.

Investing your pension

A-Day will bring a relaxation of rules governing the way you invest your pension fund.

The biggest proposed change is the decision to allow investment in residential property with a 40 per cent tax break. At present you can only invest in commercial property. Other investments could include art and wine.

Companies will have to rewrite their pension schemes, especially with regard to higher earners who will be heavily penalised if the traditional benefits mean they breach the lifetime limit.

McPhail says: "People with company pensions are just as susceptible to the lifetime limit as anyone else - more so in some ways, given the relative generosity of defined benefit pensions. "So the message for everyone is to get in touch with your pension administrators, and obtain a valuation of your pension rights as at 6 April. Keep that valuation safe, in case it is needed years later."