For many people, their pension fund/s is one of the biggest assets, one which you?ll have worked hard to build up during your working life. But how much of the balance will you be able to leav
For many people, their pension fund/s is one of the biggest assets, one which you?ll have worked hard to build up during your working life. But how much of the balance will you be able to leave to your family as an inheritance? What happens when you buy an annuity, and how much will be lost to the UK taxman?
UK pension funds and inheritance tax
Many people presume that their pension funds are free from UK inheritance tax (IHT) and other taxes on death, but this is not necessarily the case. Your UK pension fund will be liable to taxes on your death if:
- You have only taken your tax free cash now officially known as Pension Commencement Lump Sum (PCLS) since 6th April 2006.
- You have taken some income from it, however little, and have not purchased an annuity.
Once you have bought an annuity, your pension fund will be free from IHT and other UK taxes on death ? but when you consider that purchasing an annuity means there is nothing available to leave your heirs other than a spouse?s or dependent?s pension, there?s nothing to cheer about. When you die an annuity usually dies with you and you cannot leave any balance to your family.
Provided you are non-UK domiciled (and not just non-UK resident) on your death, British expatriates escape IHT on their non-UK assets. However UK based assets and potentially pension funds, remain liable for IHT if your total UK estate is worth over ?325,000 (the current IHT threshold).
Transfers between spouses are free from IHT, unless the recipient is a non UK domicile, but even then pension funds may not escape tax even if there is a transfer between spouses on death.
35% tax on income drawdown
If you are under age 75 then once you start to take benefits from your pension fund but have not purchased an annuity it will be subject to a 35% tax charge on death, charged to the pension trustees.
This applies even if you have only taken your tax free cash from your fund and have not yet taken any income.
Since this tax is not IHT the normal IHT rules do not apply. There is no exempt allowance between spouses. You can avoid this tax charge by arranging for your spouse to continue with the drawdown arrangement, but you cannot escape it forever as the tax will be levied on the second death.
The domicile rules do not apply either, so even if you have lived abroad for many years and completely broken ties with the UK, this 35% tax charge still applies to your UK pension fund.
Alternatively Secured Pensions – the alternative to annuities
Annuities are potentially expensive and restrictive ? not to mention that annuity rates are currently at record lows.
While you are no longer required to buy an annuity, the alternative is not particularly attractive either.
If you do not buy an annuity by the time you are 75 years old, you will automatically be transferred into an Alternatively Secured Pension (ASP) instead. This works in a similar way to drawdown, but with lower levels of income. You cannot defer your pension income after age 75.
And ? significantly ? the tax charges on death can be as high as 82%, depending on your domicile. This is made up of an increased tax charge of 70% plus IHT on the balance.
QROPS ? the solution to avoiding UK taxes on death
The solution for many British expatriates is to move their pension funds out of the UK and into a Qualifying Recognised Overseas Pension Scheme (QROPS).
Once you have been non-UK tax resident for five complete and consecutive tax years, and provided you are still non-UK resident at the time of your death, then your pension fund will escape the usual UK tax charges levied on your pension trustees, allowing you to leave your family all of the remainder of your fund.
There is no requirement to buy an annuity with a QROPS (though you can do so if you wish). If you do not buy an annuity, the fund can be passed on your heirs according to your wishes. And even though you have not bought an annuity, your fund will still escape the UK tax charge on death of up to 82%.
Transferring your pension into a QROPS can therefore result in significant advantages for your heirs. They will be able to receive the entire balance when you die, rather than potentially most of it going to the taxman or all of it to a life assurance company supplying your annuity.
It can also result in tax savings for yourself, thereby increasing your pension income. No UK PAYE is payable on income from a QROPS and your pension can roll-up tax free in a QROPS. Taxation of withdrawals is usually more beneficial than if you keep a UK pension fund (depending on where you live). With professional advice you can usually set up your QROPS to provide tax efficient income in your country of residence.
Besides the tax advantages, QROPS also allow expatriates to choose the currency of denomination and income, thus removing the risk of fluctuating income as well as exchange rate costs. With increased investment and income flexibility available within a QROPS, you can set up your fund to suit your expatriate lifestyle and needs.
QROPS can provide many benefits for expatriates as well as for your family when it comes to inherit your fund. If you are non-UK resident or about to leave the UK and have one or more UK private pensions, it is certainly worth considering a move into QROPS. Seek advice from a wealth management professional like Blevins Franks to explore your options and ensure it would be an appropriate move for you.
By David Franks, Chief Executive, Blevins Franks
24th December 2009