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   Prerogative instruments    Public service scheme    Preserved benefits
   Private managed funds    Purchase life annuity    Protected rights
   Private pension scheme    Professional indemnity    Property

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Prerogative instruments
The Armed Forces Pension Scheme is a final salary, contracted out, unfunded occupational pension scheme and its rules are set out in prerogative instruments. These documents are not subject to approval, annulment or amendment by parliament, they derive their authority directly from the Queen.

Under the Naval and Marine Pay and Pensions Act 1865, the prerogative instruments for the Royal Navy and Royal Marines is by an Order of Council, for the Army it is the Pensions Warrant 1977 and for the RAF it is the Queen's Regulations for the Royal Air Force.


Preserved benefits

Members that leave a final salary pension before their normal retirement age with 2 or more year's service can have their benefits held in the scheme until the stated retirement age. The benefits will be index linked at the rate of inflation or 5.0% whichever is the lower.


Private managed funds
An individual can invest via a self invested personal pension scheme (SIPPs), an insured personal pension or private managed funds (PMFs), the latter being midway between the other two extremes. PMFs have similar investment restrictions and advantages as SIPPs but operate as a normal insured personal pension, having a fund link that is unique to the individual or partners in a partnership.

The life assurance company will own the assets of the PMFs so these funds must satisfy various regulations. This includes the private managed fund managers being authorised by the Financial Services Authority (FSA) so technically the individual or partners cannot personally manage the pension fund, as is possible with a SIPPs.


Private pension scheme
Where an employer does not have an occupational pension scheme or where an individual is not eligible to join their employers pension scheme or wants to make additional contributions independent of the employer, they will have to establish a private pension scheme. This could be a defined contribution personal pension or a stakeholder pension. Contributions made will usually be wholly by the scheme member although occasionally an employer will make a percentage contribution.

Since 6 April 2006 Pension Simplification has replaced eight tax regimes and introduced two new controls. Firstly there is a Lifetime Allowance where the maximum amount of pension savings that can benefit from tax relief and has been initially set at £1.5 million for the 2006/07 tax year increasing to £1.8 million for the 2010/11 tax year. The other control is the Annual Allowance that limits the amount that can be contributed to a pension to £215,000 for the 2006/07 tax year rising to £255,000 by 2010/11 tax year. However, the rules allow an individual to contribute either £3,600 per annum or 100% of their earnings in order to benefit from tax relief at their marginal rate of tax.

Previous to A-Day the contributions to a personal pension were limited by Inland Revenue maximums, depending on the age of the member, between 17.5% to 40.0% and a stakeholder pension limited the contributions to £3,600 per annum irrespective of age or pensionable earnings.

The pension fund value that determines the pension income at retirement age will depend on contributions made and the investment return. The individual can use it to buy an annuity and has the option to use an open market option to search for the highest pension annuity. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised pension annuities quote offering guaranteed rates.

An individual can also establish self invested personal pensions (SIPPs) that allow a wider investment choice. As a member of an occupational pension scheme the individual could make private payments to a free standing additional voluntary contribution scheme (FSAVC) that is separate from the employers scheme but they will still be limited to total contributions of 15.0% of total earnings as set by the Inland Revenue.


Professional indemnity
This is insurance taken out by independent financial advisers (IFA) and other professional advise to protect clients from financial loss as a result of fraud or negligence by that firm and where the firm does not have the short-term reserves to pay compensation. In exceptional circumstances, such as the pensions review, professional indemnity insurance may not be sufficient to protect the assets of the firm.


Property
In many parts of England & Wales and Scotland the pension arrangements could easily be the most valuable asset of a couple on divorce, judicial separation and nullity of marriage. In the southeast of England it is usually the case that the largest asset class will be property, including the principle residence as well as other investment property.

The most significant capital gains tax (CGT) exemption for most individuals will be the principle private residence. However, part of the gain on this property may be taxable if it has not been the principle residence for the whole of the period of ownership.

If in addition to the principle private residence the owner has a second home or a buy-to-let property, then this property will be subject to CGT on disposal. It is possible for an individual with two properties or more to make an election regarding the principle residence. This election must be made within 2 years of purchasing the additional properties and the decision can be changed so long as it is within the 2 year period.

The gain on disposal of an investment property can be reduced by deducting from the disposal proceeds the acquisition costs as well as the associated costs of acquisition and disposal and any improvements. Furthermore the owner can applying indexation relief for property before 5 April 1998, taper relief from 6 April 1998 and their CGT exemption of £7,700 for the 2002 / 2003 tax year.


Protected rights
Where an individual contracts out of the state earnings related pension scheme (SERPS) using a personal pension or stakeholder pension, a rebate of some of the National Insurance (NI) paid for that person is paid to the pension provider sometime after the end of the tax year by the Inland Revenue. These rebates are known as protected rights contribution.

Protected rights funds must be held separate to other pension funds where the benefits may not be taken until age 60 and then they must be taken wholly as pension income with no commutation to a tax free lump sum. Where contracting out is via an occupational defined contribution scheme, protected rights contributions are made up from a flat rate percentage reduction in NI contributions plus an age related rebate after the end of the tax year.

Under a defined benefit scheme the pension transfer value equivalent of any guaranteed minimum pension (GMP) entitlement earned up to 5 April 1997, plus all benefits earned after 5 April 1997, must be treated as protected rights if transferred to either a personal or stakeholder pension.


Public service scheme
The civil service, armed forces, NHS, teachers, fire, police and local authorities have access to a public service scheme for retirement benefits and where the scheme rules and regulations are defined by statue. In the case of the principal civil service scheme, there is no direct cost to the scheme member as it is non contributory.

This is in contrast to the NHS pension scheme where scheme members are expected to contribute 6.0% of their pensionable earnings. The accrual rate for public service schemes is 1/80th of the final salary for each year of service with a maximum pension income of 40/80ths for forty years of service, or half final salary.

In addition there will be a non-optional tax free lump sum calculated as 3/80ths of final salary for each year of service with a maximum of 120/80ths for forty years service. The member can elect for an increase in pension income at retirement age by the commutation of the tax free lump sum. However, the pension income will be taxable as earned income. The pension income and widows pension are subject to limited price indexation (LPI) and payments will rise by the retail price index (RPI) but are capped at 5.0%.

In cases of pension sharing section 36 of the Welfare Reform and Pensions Act 1999 (WRPA) allows for indexing benefits so a pension credit acquired by the former spouse will equal those terms enjoyed by the scheme member. As statutory schemes are either unfunded or notionally funded, there is no need to comply with the minimum funding requirement (MFR) as pension benefits are guaranteed by statute, unlike private sector employers pension schemes.


Purchased life annuity
A scheme member could create more pension income at retirement age by applying their commuted tax free lump sum to a purchased life annuity. This is an annuity purchased by a private individual with a lump sum ceasing on the death of the annuitant.

Under section 656 of the Income and Corporation Taxes Act 1988 (ICTA) the income is regarded as capital and interest. The return of capital that is free of tax but the interest element will be taxable at the savings rate of tax of 20%. This is the same as a pension annuity or compulsory purchase annuity for a pension where all the income is taxed as earned income at a rate of 20% for the 20009/10 tax year.

This makes the annuity taxation of a purchased life annuity very favourable compared to a pension annuity and it provides a higher income net of tax. Therefore the majority of individuals on retirement that want to maximise their pension income should commute the maximum tax free lump sum and use this for a purchased life annuity.

A purchase life annuity offers the annuitant many features such as fixed rate escalation or a guaranteed period that are similar to that of a pension annuity. To protect the lump sum in the event of the early death of the annuitant, this annuity can also provide capital protection where the balance between the original lump sum and actual premiums paid is paid to the annuitant's estate.

For a family with an elderly relative that now requires 24 hour care after suffering an illness, the long term care costs for a nursing home could be partially funded, after any contributions by Local Authority or NHS funding, by an immediate needs annuity. This is similar to a purchased life annuity in that a lump sum is used to purchase an annuity. The main difference is that the annuitant is usually aged from 80 to 90 years, have a medical condition and the annuity is paid directly to the nursing care home totally free from tax.

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Annuity Rates
Single
  55 £4,164  
  60 £4,625  
  65 £5,370  
  70 £5,980  
Joint
  55 £3,918  
  60 £4,367  
  65 £4,895  
  70 £5,348  
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