Consumer confidence in saving for retirement will be eroded, the pensions industry said, after the Government performed a U-turn on a new type of pension introduced less than a year ago.

In a paper published alongside the pre-Budget report, the Treasury announced changes to alternatively secured pensions (ASPs), introduced under sweeping changes to pension legislation known as A-Day in April 2006.

The product eliminated the need to buy an annuity at age 75 and meant that a pension fund could remain fully invested and passed on upon death, subject to inheritance tax (IHT).

ASPs were primarily designed for those with religious objections to annuities. Prominent among them were the Plymouth Brethren who objected to the process of taking a gamble on the date of one's death, which is effectively what an annuity does.

Companies providing annuities pay a regular income in exchange for a lump sum. The company that sells the annuity estimates how long the customer will live and pitches the level of the annuity accordingly.

The government had expressed concerns that ASPs were being used more widely than it intended – particularly for tax avoidance purposes.

Now it has said that, from 6 April 2007, those with an ASP will have to take a minimum income and death benefits will be taxed.

People will need to take an income equal to at least 65 per cent of the annuity that could be bought using the ASP fund.

The maximum income level, currently 70 per cent, will be hiked to the equivalent of 90 percent of the comparable annuity.

Assets left in the fund when the member dies will be subject to tax of up to 70 per cent, potentially on top of any IHT liability.

Pension and tax experts said the move effectively killed off the product.

Andrew Tully, pensions technical manager at Standard Life, said: "This is an extremely disappointing move by the government, which will further damage the already low confidence which people have about pensions.

"Some investors do not believe that an annuity gives them best value from their pension savings.

"To introduce punitive tax charges on the only alternative which people have after age 75, so soon after introducing the product, is a backward step."

Tim Gregory, a partner in the private wealth group of chartered accountant Saffery Champness, said the move was a "blow" to the pensions industry and the "many people who were beginning to think about putting their trust in pensions again".

"It will do nothing to encourage people to save for their retirement, which is odd since that seems to be one of the government's objectives," he said.

"It is also bizarre that such a high rate of tax should be imposed, and we shall have to wait for the details to see how this will work."

However, others welcomed "clarity" on ASPs, which some industry figures had thought might be scrapped altogether.

Madeline Forrester, head of UK distribution at Threadneedle Investments, said: "The government has finally brought more clarity to what was an area of some doubt. We think this makes the ASP a viable alternative to an annuity."

The changes could also prove a boon for charities, as ASP funds left to good causes will not attract tax.

Kate Ragnauth, director the pensions arm of Charles Stanley, said: "Effectively, you are faced with heavy tax charges if you leave your residual funds to your beneficiaries, but if you gift the payments to charity instead they will be exempt.

More Birmingham Post pre-Budget stories:

>> Brown blasted for 'feeble' report
>> Brown fails to go green
>> Sir Digby sets sights on skills
>> Political Editor Jonathan Walker gives his opinion
>> Birmingham Chamber of Commerce & Industry's reaction
>> Air fares to rise
>> Pension fear over u-turn
>> Brown cautious but not frugal

>> Read Gordon Brown's speech in full
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