What the latest UK pension tax changes mean for International investors

For full details of the UK pension tax changes, please refer to our UK Knowledge Direct website article: ‘The new pension regime from 6 April 2011’.

There are only three areas of change for international investors:

• A new anti-avoidance provision affecting non-UK tax resident individuals who take advantage of the new flexible draw down facility for UK registered pensions. From 6 April 2011, withdrawals made under the flexible drawdown arrangement whilst non-UK tax resident will be taxed if they return to the UK within 5 tax years;
• A new anti-avoidance provision affecting UK tax relieved funds for relevant non-UK relevant schemes and overseas pension schemes (this includes QROPS, overseas pensions where migrant member relief applies and EFRBS in respect of tax-exempt benefits payable on retirement or death). The provision applies to withdrawals from 6 April 2011 and mirrors the anti-avoidance provision for UK registered pension schemes.
• The changes to UK registered pension rules have diluted some of the previously promoted benefits for QROPS, and one of those benefits has been removed.

Overall, the impact is minimal for QROPS business aimed at clients who intend to retire abroad permanently.

Non-UK tax resident individuals* who remain in UK registered pension schemes and take advantage of the new flexible draw down arrangement** that take effect from 6 April 2011, need to be aware of the new anti-avoidance legislation. This taxes withdrawals made whilst non-UK resident when the individual returns to the UK and becomes a UK resident again, if they return within five tax years. This also applies to withdrawals made from a dependant's flexible drawdown pension. There will be no offset of tax paid on the income whilst outside the UK, even where a double taxation agreement exists.

This provision does not impact the payment of a pension commencement lump sum to the individual.

This anti-avoidance provision could lead to individuals considering other vehicles to provide retirement funding where they only expect to be non-UK resident for short periods, such as offshore bonds with appropriate IHT planning.

*For this tax deferral to apply they must have also been a UK resident for 4 out of the 7 tax years immediately prior to the year of leaving the UK.

**For an explanation of how the new flexible drawdown arrangement works, please click here and go to the the section link 'Removal of effective requirement to annuitise at age 75'. Use your back button to return to this article.

Example

Doug is 60 and has lived in Spain for the last two years since moving from the UK for his work. Doug holds a UK registered pension scheme and has sufficient pension income from other eligible sources to meet the requirements that allow him to make use of the new flexible draw down arrangement from 6 April 2011.

Doug withdraws 50% of his pension (£150,000) under the flexible arrangement.

In October 2012, Doug returns to the UK as his mother is ill. Doug, will be liable to UK income tax on the £150,000 in the 2012/13 tax year as he has become UK tax resident within five tax years of taking the withdrawal.

The anti-avoidance legislation will take effect from 6 April 2011.

It applies to pension income (paid to either the member or a dependent) from an overseas pension or relevant non-UK scheme.

It has no impact on Pension Commencement Lump Sums.

The definition of such schemes includes:

• transfers of UK tax relieved funds from a registered UK pension to a Qualifying Recognised Overseas Pension Scheme (QROPS),
• transfers of UK tax relieved funds between QROPS,
• Recognised Overseas Pension Schemes and Overseas Pension Schemes in receipt of contributions which receive UK tax relief under the migrant member relief provisions; and
• UK tax-exempt income paid on death or retirement of an employer sponsored overseas pension scheme such as an Employer Financed Retirement Benefit Scheme (EFRBS).

It does not apply to pension income taken from non-UK tax relieved funds.

Who does this apply to?

If an individual was UK resident for at least four out of the previous seven tax years before leaving the UK, and they take pension income from an overseas pension or relevant non-UK schemes while non-UK resident and return to the UK within five tax years of leaving.

A tax year in which the individual is considered resident in both the UK and another territory for the purpose of any double taxation agreement will not be counted for meeting the residence requirements for this anti-avoidance provision to apply.

Taxation of the foreign pension income

Foreign pension income (e.g. income payment from a QROPS) is taxed as earned income on 90% of the pension income amount. The anti-avoidance provision also means there is no reduction in the tax due to reflect any tax paid on any of the pension income in another territory, even where a double taxation agreement is in place.

Aim of this provision

The provision is designed to target abuse of the UK tax system for pensions by individuals leaving the UK for short periods to access their UK pension funds from a QROPS or other relevant vehicle. It is therefore important for individuals and their financial advisers to be aware of and understand the implications of this legislation where they either hold a QROPS or intend to transfer to a QROPS so that they do not innocently trigger this provision. An example of how this works follows.

Example

Julie is 65 and has lived in Italy for the last three years since moving from the UK. She decided to transfer her UK pension funds into a QROPS. She retired last year (1 January 2009) and began to receive an income of £20,000 per year from her QROPS. She pays tax on the pension income at 27% in Italy.

Julie’s daughter Barbara had a baby this year and Julie has agreed to move back to the UK to help her daughter to raise the child for a few years before returning to Italy. Julie returns to the UK in May 2011 and becomes UK tax resident for the 2011/12 tax year. She is not considered Italian resident for this tax year.

Because Julie was:

• UK tax resident for all 7 tax years before leaving the UK, and
• there have been less than five tax years between leaving the UK and returning, and she has taken pension income from her QROPS,

she will be liable to pay income tax on 90% of the total pension income amount taken whilst she was non-UK resident (90% of £60,000). £40,000 of this amount was taken while she lived in Italy, and although she has incurred tax on that income in Italy, she is not able to reduce the amount of tax she will pay in the UK.

Had Julie returned to the UK more than 5 tax years after she had departed, then she would not be liable to pay income tax on her QROPS pension income from the years when she was non-UK tax resident.

There remain many good reasons for the ex-pat client to consider QROPS that are detailed in our QROPS client brochure ‘Take your pension away with you’. Please also see our article ‘QROPS - the reasons why’ for details of the various benefits that remain. The previous sales benefits of QROPS that have been affected are detailed below with an explanation of the changes for UK registered pensions for context.

Need to purchase an annuity

From 6 April 2011, compulsory purchase of an annuity at age 75 (77 since 22 June 2010) is no longer a requirement for members of UK registered pension schemes. Individuals with money-purchase pension funds, who have yet to take benefits, will now be able to defer the decision indefinitely. Fortunately, QROPS have never had such a requirement.

Effective for UK inheritance tax

The tax charge for lump sum death benefits from crystallised funds (UK registered pensions which are in drawdown) where the member dies regardless of their age will be 55%, but there will no longer be an IHT charge. A 55% tax charge will also apply to uncrystallised lump sum death benefits if the member had already attained age 75.

There will be no tax charge for lump sum death benefits from uncrystallised funds where the member died before age 75, and lump sums paid to a UK charity. In normal circumstances, there will be no IHT provided the scheme administrator has discretion over making the payment.

QROPS and QNUPS continue to be exempt from IHT on the death of a UK domiciled member.

.

Restrictions on fund size

The Lifetime Allowance will reduce from £1.8M to £1.5M from 6 April 2012. Transfers to a QROPS of UK registered pension scheme funds does require assessment to see if the member exceeds this limit, but will not apply once the pension funds are held within the QROPS. There is the opportunity for individuals who believe their fund will exceed the £1.5 M limit to apply for fixed protection where they will crystallise benefits on or after 6 April 2012.

You may have greater flexibility when choosing the amount of income you take.

The new changes mean that from the age of 55 individuals may be able to benefit from a new flexible drawdown arrangement on their UK registered pension where they meet the Minimum Income Requirement (MIR) of £20,000. 

It is important to consider the types of income included for assessment of the MIR. State Pension and Additional State Pension alone are unlikely to meet the £20,000 limit, therefore the difference must come from either a level annuity income or scheme pensions. It has been estimated that for a male aged 65 (ignoring any Basic State Pension) a pension fund of approximately £300,000 would be required to achieve a £20,000 income on a level income basis or £500,000 if the income is increased by RPI each year*** (which must be guaranteed and payable for life). Although an enhancement to the flexibility of current drawdown arrangements for UK pensions, the assessment criteria restrict the use of this flexibility.

*** Source: Annuity Direct

For further details of any of the UK pension tax changes mentioned in this article, please refer to the UK article: ‘The new pension regime from 6 April 2011’.