New penalties could bring a sting in the tail
Take steps to shelter tax free cash or income

Individuals who have been prudent over the years and saved rigorously will not be pleased to hear that they may become subjected to new taxes of up to 82 per cent. However, by taking steps to shelter tax free cash or income from what are now regarded as surplus pension funds, there are ways to avoid falling foul of the new penalties.

For those people with sufficient income from sources other than their pension funds, it doesn’t mean they should leave their pension funds untouched until they die. The problem arises because of a change to the rules governing annuities. In April 2006, Gordon Brown, the then Chancellor, introduced changes to pension legislation known as "A Day."

The rules allowed those who had reached 75 and had not bought an annuity with their pension fund to opt for an Alternative Secured Pension (ASP). Although ASPs were originally introduced in response to requests from the Plymouth Brethren, who had religious objections to annuities, it soon become clear that ASPs would appeal to a much wider group.

The appeal of the ASP to wealthier investors is that they would be able to withdraw income from their pension without being forced to buy an annuity at aged 75. Then the Treasury made an about-turn, saying that ASPs were never intended as a means for wealthy people to pass on tax-advantaged savings to dependants and imposed a tax and penalty charge of up to 82 per cent on residual funds.

However, this would only apply where estates exceed the nil-rate band for inheritance tax (IHT) of currently £300,000 with the effective limit for married couples and members of civil registered partnerships being £600,000 because of the automatic transfer of spouses’ allowances.

Those most likely to be tempted to transfer their funds into an ASP are pensioners who have opted for drawdown (also known as an unsecured pension) as an alternative to more traditional annuity planning. Drawdown allows an individual aged between 50 and 75 to defer the purchase of a pension from an insurance company.

They take an income from the fund and leave the rest invested, but still need to buy an annuity or transfer into an ASP when they reach age 75. Drawdown and ASPs tend to be more suitable for people with larger pension funds (before taking any tax-free cash), or with other sources of retirement income, who may be willing to take a higher degree of risk with their retirement income.

There is a way to shelter your pension fund from the tax, but you need to plan ahead using specialist tax-efficient vehicles. Although escaping the full 82 per cent tax on any residual ASP funds may not always be possible, there are the means of making sure that the majority of any 'surplus' pension funds find their way to beneficiaries and not to the Treasury.

Pensioners who buy an ASP could withdraw tax-free cash and give it to a trust to minimise any IHT charges. If they survive for seven years after the gift, then the whole of this fund should fall outside the IHT net. They then can take a maximum pension which, being surplus to their living requirements, can be gifted each year (with immediate exemption from IHT) into a "gifts from income" flexible trust, again for IHT mitigation. As gifts are made 'out of income', there is no maximum to the sums you can pass on and you do not have to wait seven years for it to become exempt. It is important to bear in mind that, unless you set up a trust, you will lose control of any money you give away.

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Levels and bases of, and reliefs from, taxation are subject to change.