Britons risk up to 55% taxation if pension funds go over the UK lifetime allowance – but expatriates can take steps to limit exposure.

Are your UK pension funds safe from 'lifetime allowance' tax penalties? Since 2006, the UK government has capped how much you can hold in combined pension savings without paying extra tax. Originally £1.5 million, the allowance peaked in 2011 at £1.8 million before gradually falling to today’s level of £1 million. 

While this may still seem high, by counting all pension benefits outside the State Pension, it considers everything accumulated over a working lifetime, potentially including years of investment growth. As a result, more and more people are being caught out without realising it. 

If you have been diligently saving into your pensions or have several different funds, it is a good idea to review your situation, even if you have already started drawing benefits. With appropriate action now, you could protect your retirement savings from unnecessary taxation.

What are the penalties? 

Once total pension funds exceed the allowance limit, extra tax is payable whenever you access your money – technically called a ‘benefit crystallisation event’. How much you pay depends on the way funds are withdrawn – rates are 55% for lump sums and 25% for income or transfers. So at best, the price for being over can cost you a quarter of your funds, at worst: over half. 

Being non-UK resident offers no protection. Usually, under the double tax agreement, Portuguese, Spanish and French residents are not charged UK taxes on British pensions (except government service pensions). However, for those over the allowance, these rules do not apply – the lifetime allowance tax is applied in the UK first and cannot be claimed back. 

How can you check your allowance?

Calculating how much of your allowance you have used is not always straightforward. If you have a ‘defined contribution’ (‘money purchase’) pension, add up the value of your pot plus anything you have already taken. Things get trickier for ‘defined benefit’ (‘final salary’) schemes. Usually, the measure is 20x the annual income due plus any lump sum payable, but check with your provider or financial adviser.

HM Revenue & Customs (HMRC) will first test your allowance status when you start drawing your pension, then every time you access funds and when you turn 75. Each withdrawal uses up a percentage rather than a cash value of your lifetime allowance, so once you take 100% there is no remaining entitlement even if the allowance subsequently increases. If you die before age 75, any lump sums paid to your beneficiaries will also be subject to the lifetime allowance test and subsequent tax penalties.

How can you protect your funds?

You could secure a higher limit by applying for lifetime allowance ‘protection’ from HMRC. This usually has strict conditions attached, however, so take guidance first.

Expatriates have the option of transferring UK pension funds to a Qualifying Recognised Overseas Pension Scheme (QROPS). Doing this can limit your exposure to lifetime allowance penalties while providing tax-efficiency, currency flexibility and estate planning advantages. See more on the pros and cons of transferring to a QROPS

If you transfer one or more UK pensions into a QROPS and your total benefits are under £1 million, you will not face lifetime allowance taxes on the transfer. However, make sure the QROPS is within the European Economic Area (EEA), such as Malta or Gibraltar, otherwise you are likely to face an ‘overseas transfer charge’ of 25%. 

Once in a QROPS, your funds are out of reach of lifetime allowance charges, no matter how much you have in total or how you access it. Those at or close to the limit, therefore, should consider transferring and paying any tax charges now before funds – and tax liabilities – increase in value.

Another option is to take your UK pension as cash and reinvest into an arrangement that is both tax-efficient and compliant in your country of residence. In any case, before making any pension decisions, taking regulated advice is crucial to determine your most suitable approach and avoid pension scams. See more about your pension options

If you are hovering under the threshold, consider acting sooner rather than later to prevent growth tipping you over the limit. Although the lifetime allowance is not expected to drop further, it is only set to increase in line with inflation each April, so there will not be much leeway if you are already at the upper end.

Regardless of whether the lifetime allowance will affect you, with Brexit around the corner, now is a good time to review your pension options. If you are living in Portugal, Spain, France or elsewhere, you should regularly check your financial planning to make sure you take advantage of available opportunities and protect your wealth in the most suitable way for your particular circumstances. 

Contact us to discuss your pension options

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual is advised to seek personalised advice.