Understanding pensions can be a little difficult with all of the complexities involved. This article briefly clarifies six key things you need to be aware of before deciding what to do with your pensions, particularly if you plan to spend your retirement abroad. But do be aware that there is no substitute for specialist advice in this area.
Pensions is an important topic for us all. It represents a lifetime of professional effort and our reward should be enjoying a long, happy retirement without having to worry about money. You deserve to have peace of mind over your financial security and that your pension is being well managed.
But it can be complicated, can’t it?
As Albert Einstein said – Any fool can know. The point is to understand!
1) UK State Pension – what you need to be aware of
To qualify for the full UK state pension, currently £9,628 a year, you must have paid UK national insurance contributions for 35 years. Otherwise, provided you contributed for at least 10 years, the amount you receive is based pro-rata on how much of 35 years you secured.
If have already paid your 35 years of national insurance and are still working, you continue to pay contributions.
It is possible to make voluntary contributions to buy back six years if you haven’t reached the minimum 10 years.
You can obtain a UK State Pension forecast online or download form BR19 and post it to the Department for Works & Pensions.
UK nationals who are resident in the EU continue to receive the UK state pension. It’s paid gross and taxed in your country of residence, rather than in the UK.
2) ‘Defined Benefit’ pensions and ‘Defined Contribution’ pensions – what’s the difference?
People who worked for UK companies’ long term often have traditional company pensions called ‘defined benefits’ or ‘final salary’ (they’re the same thing), where the accrual of benefits is based on the number of years you worked for the company and your final salary.
These schemes are becoming more of a rarity because they created a massive ongoing liability for the company, sometimes leading to a ‘black hole’ on their balance sheets, particularly with people living longer than originally forecast.
These days employers often favour ‘defined contribution’ or ‘money purchase’ pensions, where the financial commitment is quantifiable.
Individuals have used these ‘personal pensions’ for years. The UK government encourages people to save for their retirement by offering tax relief on pension contributions – money accumulating within the pension grows tax free. They can help people create valuable pension pots, through the tax advantages, enforcing a savings culture and not being able to get your hands on your money until at least 55.
3) Understanding how personal pensions are taxed abroad
Generally, if you are resident abroad, and have applied for and received an NT tax code, your personal pensions are liable to local income tax in your country of residence, instead of UK tax (only government service pensions are taxed in the UK). This is the case with France, Spain, Portugal, Malta and (in the case of Cyprus, residents can currently elect to have their government service pension taxed in Cyprus instead of the UK, but only until 2024).
If you are resident in or moving to Spain, note that Spain also applies an annual wealth tax. Although pension plans are generally listed as one of the assets exempt from wealth tax, a 2019 ruling by Spain’s Directorate-General for Tax (DGT) concluded that non-EU pension plans do not qualify for the wealth tax exemption. This means that Spanish wealth tax now applies to a UK pension fund (from the point at which a member can take benefits) and will be added to your other worldwide assets to calculate your tax liability each year.
4) What is the ‘lifetime allowance’?
In simple terms, the lifetime allowance is the maximum combined amount you can accumulate in UK pensions (excluding state pensions).
Introduced in 2006 with a £1.5million threshold, it gradually increased to £1.8million before being slashed to £1 million by 2016. It then increased with inflation to £1,073,100, but the 2022 UK budget froze it for the next five years.
Any amount above the lifetime allowance is subject to a one-off tax charge of 25% if the excess is paid as a pension or the pension fund is transferred abroad, jumping to 55% if paid as a lump sum – it can be a combination of both.
It is not limited to UK residents, so continues to affect expatiates
5) What benefits do QROPS bring?
A Qualifying Recognised Overseas Pension Scheme is an overseas pension created to receive monies from UK pensions when the owner has moved abroad. To be able to receive the monies from a UK pension, the QROPS must be recognised by HM Revenue & Customs, so there is some degree of comfort in that fact alone.
One popular reason many expatriates transfer UK pensions to QROPS is to avoid further lifetime allowance charges. Once in a QROPS, your pension can safely accrue and appreciate in value without running the risk of the 25% or 55% tax charge.
Many expatriates decide that since they have left the UK, why leave a major asset behind, completely at the mercy of the UK taxman? Remember, prior to 2006 you could save whatever amount you wanted in your pension without a tax penalty. And the £3 trillion in UK private pensions could be a massive tax target for any future chancellor or government.
Another reason for transferring is currency. UK pensions are paid in Sterling, which is not helpful if most of your expenses are in Euros.
More recently, another big driver is that UK financial advisers and pension firms can no longer, post-Brexit, offer European residents advice or guidance – and pensions are so complex, with so much at stake, professional advice really is necessary here.
Note for Spanish residents and those moving to Spain
Be aware that the situation is now different in Spain. In 2021, the Directorate-General for Tax issued binding ruling V2508-21 which determines that unless a pension is either a Spanish pension contract or an EU pension, a pension transfer from a ‘third country’ pension scheme to an EEA pension scheme will be subject to a personal income tax charge on the whole fund value. Therefore, if a Spanish tax resident transfers a UK pension fund into a QROPS (even an EU QROPS) they will be hit by this tax charge.
You could potentially avoid this tax charge by transferring your pension into a QROPS before you move to Spain. Those who move to Spain in the second half of the year may also have a short window to transfer to QROPS, if they will not be deemed a Spanish tax resident until the following January. It is very important to take up-to-date specialist professional advice before making pension decisions.
6) What about the ‘overseas transfer charge’ – should that concern us?
The overseas transfer charge was introduced in the 2017 UK budget to deter people from transferring their pensions out of the UK for what the then Chancellor described as purely tax avoidance reasons. What that really meant was, ‘we’ve allowed you to accumulate pension benefits in a beneficial tax environment; now you’re moving away we won’t see any tax revenue, so will apply an exit tax’.
Importantly, currently not all QROPS transfers are subject to the overseas transfer charge. For example, if you live in the EU and transfer to an EU QROPS, the charge won’t be applied. But be careful, if you move outside the EU within five UK tax years of making a transfer, in many instances the overseas transfer charge can be applied retrospectively.
What does the post-Brexit future hold?
As time passes, we’re learning more about what post-Brexit life in the EU looks like; what’s actually changed and what hasn’t, and what may change in the future.
The best news must be that the UK will continue to uplift UK state pensions, the same as if you were living in the UK. It will continue to honour the S1 system for those receiving UK state pensions, including for people who are not eligible yet.
However rules can change, and now the UK is outside the EU/EEA it could very easily extend the overseas transfer charge to EU residents.
It could decide to change the rules completely, renegotiate the double tax treaty (as it did with Cyprus), and tax all UK arising income in the UK, as UK rental income and government pensions already are.
From the Treasury’s perspective, one attractive option would be to remove personal allowances for non-UK residents, so expatriates would pay UK income tax on every penny of UK income. We won’t pay twice because of the double tax treaty, but we could easily end up paying more than we need to.
If you haven’t considered the impact of what might initially seem like quite subtle changes, you need to dig a little deeper into what the ramifications could be for you, and importantly if there is anything you can do about it.
The bottom line is that pensions is an area that can be complex with some pitfalls not immediately visible and one to seek expert advice on. We all like doing a little bit of DIY from time to time, but not if it could adversely affect our hard-earned wealth. Albert Einstein had a point!
Blevins Franks has a team of pension specialists who support our advisers living locally. We have more than 45 years’ experience helping British expatriates make the most of their pensions in the most tax-efficient way possible while living abroad.
Contact Blevins Franks today.
This article is only intended as an introduction to the pension issues you need to be aware of and the views are put forward for consideration purposes only. Pensions is a complex area, and one where the rules can change frequently, and it is important you seek personalised and more detailed advice.
