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Update July 2015 – in the ‘Summer Budget’, the Government announced a change to Pension Input Periods (PIP) which essentially brought the rules (which became effective immediately) in line with what most non-pension ‘consumers’ assumed all along – that the PIP is aligned with the tax year end. The Government also removed the ability to end PIPs early.

Like it or not, everyone’s PIP ended at midnight on 8th July 2015 and a new PIP opened up on 9th July which will then end on 5th April 2016.

I leave the following article as a testament of  ‘what once was’ given that this serves to demonstrate not only how things are not always as they appear, but also that legislation change is the norm for pension and broader financial planning…..

Original article: Pensions are (perhaps) one of the most complicated tax wrappers known to mankind – not only are they a source of amusement to politicians of all colours as a result the constant tinkering with various rules, attributes and regulations but they are also a source of huge misinformation and misunderstanding (but I’ll save that soap box rant for another day).

The irony is that not only can they be very complicated, they are also very useful – not least as a result of wide sweeping changes due to take effect next week which result in significant flexibility, increased tax effectiveness and the ability to pass wealth on between generations (again, something else I’ll save for another day).

So back to the task in hand – the wonderful world of PIPs…. not quite as complicated as quantum physics but not far short of that weird and wonderful subatomic world.

I wrote previously concerning the concept of ‘unknown unknowns’ (see here) – one area of particular ‘danger’ when it comes to pensions is the fact that the end of the personal tax year (i.e. 5th April) has virtually nothing to do with the amount that can be funded into pensions on an annual basis.

The amount you can fund is down to the Annual Allowance and how this is calculated is actually down to the Pension Input Period (the ‘PIP’) of the scheme/plan to which the payment is being made (i.e. NOT the tax year end).

The current annual allowance is £40,000 and therefore if someone funded £40,000 on 1st April 2015 (i.e. in the current tax year) and a further £40,000 on 20th April (i.e. in the next tax year) these are very likely to both form part of the same PIP and thereby that individual would have breached the Annual Allowance of £40,000 given that £80,000 has been invested.

However, as another example, two payments of £40,000 (i.e. a total of £80,000) could be made on 1st April to two different schemes (with different PIPs). This would initially seem foolish given that the Annual Allowance is £40,000 however if one PIP ended on 1st April and the other on 20th April then this £80,000 would be permissible given that the PIPs ended in different tax years!

I am sure that the notion of PIPs is alien to the vast majority of people who are funding pensions, but for those who are making significant contributions, this is something they need to be very aware of given that exceeding this would result in a tax charge (and in most circumstances, making the excess contribution arguably pointless).

Furthermore, aggressive funding can be achieved by clever use of PIPs (as demonstrated in the £80,000 example above).

Bring into the equation that those with multiple policies will have multiple PIPs, that the Annual Allowance has changed on numerous occasions recently, that unused allowances from previous years can be carried forward and that PIPs can be changed, then a simple question of ‘how much can I pay into a pension this year’ becomes a mammoth task of data gathering and ‘Annual Allowance testing’ before an accurate answer can be given.

So next time you ask a Financial Adviser the seemingly simple question ‘how much can I pay into my pension’ please don’t be surprised if you see their body slump a little as they take a deep breath and begin with…. “well, it’s complicated because….”

Alternatively, if they are quick to answer £40,000 you might want to flex your pension muscles and ask them ‘but what about my PIPs’!

In the run up to the changes to pension legislation, much of media (and political) coverage focused on costs and freedom. On the one hand, Ed Miliband seemingly couldn’t mention pensions without also using the term ‘rip off’ (Telegraph, Guardian, FTAdviser) whereas on the other, it would appear that Lamborghini (BBC) would be very busy come April….

5th April 2015 came and went and not a great deal changed for many – other than the small matter (for those interesting in facts rather than) that pensions suddenly became significantly more flexible and, potentially, even more tax effective.

Prior to April, pensions were primarily used to provide income in retirement; either a guaranteed income (an annuity) or an income which isn’t guaranteed but could potentially be paid at a higher level (drawdown).

Pensions, therefore, were all about providing an income stream and they essentially helped people defer income until a later date (and hopefully to a time where they pay less tax).

On death, funds in payment would either be taxed heavily (55% on lump sum death benefits in drawdown), potentially lost (if no death benefits were arranged on an annuity) or paid to a dependent. Dependent here being the key word – once benefits were drawn, the scope to pass on benefits became restricted and, potentially, subject to significant tax.

Moving on, we’re now in a new world….. two key things have changed.

Firstly, pensions do not have to provide income – funds can be withdrawn as the recipient sees fit and whilst the technicalities of this are outside the scope of these musings, the principle is that a quarter of those funds are tax free and the rest is taxable as income – irrespective of whether that ‘income’ is taken on the drip or as a lump sum.

At a stroke, this opened up control and flexibility…. and in turn, tax management opportunities.

Someone in semi retirement can top up their income using their private pension whilst they wait for the state pension date to arrive and if personal income tax allowances aren’t being fully used, funds can be withdrawn and whilst taxable, the proceeds would be tax free as far as they fall within the personal allowance (See here).

This also removed what could sometimes be seen as a hurdle to pension planning – the notion that you lose control of capital – whilst the fact remains that benefits can’t currently be accessed until 55 years of age at the earliest, thereafter access and control awaits the investor.

Secondly, there is much more control, choice and potentially tax effectiveness with regard to lump sum death benefits. For starters, if death occurs prior to 75 years of age all death benefits are now tax free – potentially saving the beneficiaries of those in drawdown a 55% tax charge on lump sum death benefits OR avoiding income tax where benefits are received on the drip.

Alongside that, it is now the case that income can be passed to non-dependents – anyone in fact – providing the provider permits it and you make the necessary arrangements to request it. What’s more, there is no tax charge on the transfer of assets to the beneficiary – giving them scope to ‘inherit’ the pension fund.

This therefore opens up the notion of ‘family pensions’ where funds could cascade between generations – something many may well see as a useful development.

Therefore rather than funds heading for the exits, our experience is quite the opposite – pensions are now even more tax effective than ever. Not only do payments attract Government tax relief, the funds still grow tax effectively and are generally are not liable to Inheritance Tax.

Once withdrawals are needed, a bit of planning can help to mitigate income tax as far as is possible – with funds now being withdrawn as and when needed.

As time moves on, there should be peace of mind that, when the time comes, the funds can pass on to other generations – providing the necessary steps are taken by the policy holder to arrange this – potentially giving the beneficiaries a head start to their own retirement planning.

The very nature of pensions has therefore changed and for many they may well need to look again at the opportunities they bring and whilst the treatment of their funds on death may be at the back of their thoughts, this may in fact need closest attention given that unless adequate steps are taken, the beneficiaries of the funds may find that they are unable to take advantage of the new rules.

Therefore rather than getting overly excited about sports cars or getting depressed about ‘rip off charges’, perhaps the message should be much more positive – financial planning has suddenly been blown wide open and, more than ever, people have the opportunity to live the retirement life they have perhaps always dreamed of.

Love them or hate them, pensions typically involve people having strong points of view whilst also being the subject of political interference.

Since 2001 we have had a raft of changes – the advent of stakeholder pension charge caps and the associated legislation on employers, the (now laughable!) pension simplification in 2006, changes to state pension provision (and timing), fluctuations in pension funding allowances, automatic enrolment obligations on employers and now the ‘pension freedoms’ which are due to commence in April 2015.

If anything keeps financial planners on their toes, it’s pensions – however those of you who are lucky enough not to need to keep up with the latest developments may well find that your views of pensions are clouded by misinformation, misunderstanding and – perhaps – a general detachment from reality.

There are key changes taking place in April and whilst there is too much to cover in a post like this (and if detail was provided, there is a danger of perceived advice!) there are some key (dare it be said ‘exciting’) developments taking shape.

Pensions have always offered a tax effective way to invest – giving people the ability to invest in assets which grow virtually free from tax, offering 25% of the fund ‘tax free’ whilst also deferring income tax (with the objective being that benefits are drawn in a lower tax environment that that when funds are invested). In summary, pensions typically offer a very tax efficient way of creating income in retirement.

The main ‘issue’ with pensions is that capital control is lost and whilst for those seeking to generate income in retirement this is not generally a concern, for others it can be a genuine objection.

From April 2015, however, this potential ‘barrier’ is removed once the age of 55 is reached given that access is permitted without restriction; however perhaps the greatest change is that pensions will be able to be passed on not only between spouses/dependents but also between non-dependent beneficiaries – therefore offering scope to cascade pension wealth between generations.

Pensions will therefore enable individuals to build up funds which will be paid free from tax in the event of death before 75 and if death occurs after 75, the tax charge on death on funds could be as low as 0% (currently, it stands at 55%).

Add to this the flexibility that individuals will be able to draw income or lump sums from their pensions as required – not only does a pension continue to offer the tax effectiveness it always has done, it opens up freedom of access once an individual reaches 55 and also offers a means to shelter assets from Inheritance Tax for longer!

For those who are looking to retire early and specifically have no other taxable income (i.e. they have not yet drawn their state pension) the new rules will provide the opportunity to potentially draw up to £14,133 (in tax year 2015/16) without any tax liability – £28,266 for a couple – with the expectation that this annual figure will increase in years to come.

Historically, therefore, pensions were used to provide income ‘on the drip’ – the new rules will permit investors much greater flexibility to generate tax effective income based on their personal circumstances.

Whilst ‘unknown unknowns’ can cause untold damage to financial wealth, it is also important not to overlook other potential opportunities that legislation change often brings – given all of the above and the number of misconceptions associated with pensions, it is therefore perhaps time everyone gave them another ‘look’!