As an expat, we have a mountain of information related to pensions to sift through in order to simply understand how to comply with contribution requirements while living and working abroad. Then we need to ensure we’re getting the most value from our pension, which could entail an overseas pension transfer, a deferment, a lump sum cash in, or a number of other options. Then there are tax considerations, both in your home country and the drawing country.
Needless to say, it’s worth taking independent financial advice to help you navigate the byzantine pension regulations. In this section, we outline the most common options for expats to contribute to, and receive the benefit of, a pension.
Pensions and Tax
Pensions can benefit from some favourable tax conditions, for example they grow free from capital gains tax and you may be able to take a 25% tax free lump sum when you begin drawing down on the pension (PCLS). The different types of pensions often face different tax conditions and it is important to get advice from a professional. If you reside abroad or intend to retire abroad it is best to consult a professional who is familiar with the offshore market and working with expats.
Any UK pension income will be subject to income tax at your marginal rate regardless of whether you live in the UK or not. QROPS and QNUPS could help an expat to mitigate UK income tax as they are based offshore and will be subject to the local tax rate instead.
DB schemes will not be liable for inheritance tax as they are not your personal asset, but any benefits that are passed to the spouse will add to their income and be taxed at normal marginal rates. DC schemes are a personal asset and will be counted in your estate value.
Savers with DB and DC schemes face a tax bill if their pension grows to an amount higher than the lifetime allowance (LTA). The LTA is currently £1,073,100 but this threshold could change. When a benefit is accessed, known as a benefit crystallisation event (BCE), HMRC will look to see what the total value of the pension is. If the value of all of your pension benefits, across all schemes, exceeds the lifetime allowance, any excess attracts a tax charge of 25% if it is withdrawn as an income (for instance from an annuity or a drawdown arrangement) or 55% if it is withdrawn as a cash lump sum.
This event then happens again when the pension holder turns 75. It may be possible for some people to apply for LTA protection, which can increase their LTA amount to £1.25m.
If you are a member of a DC scheme, the value of your benefits is the value of your pension pot in that scheme.
If you’re a member of a DB pension scheme, the value of your benefits is calculated as 20x the pension that you have accrued under the scheme plus any tax free cash that you received (if you have been drawing income since before 6 April 2006, this income payment is valued by multiplying by a factor of 25).
For expats who know they are approaching or have crossed the LTA, moving to a QROPS could be a good way to protect against this tax.
Understanding Pension Terminology
GMP – Guaranteed Minimum Pension. Most DB and some DC schemes will have a GMP figure; this is the legal minimum that the scheme is required to pay a member.
PCLS – Payment Commencement Lump-Sum. This is a tax-free amount that can be taken from DB/DC schemes (not state pension) up to 25%. If taken from a DB scheme the member will see a reduction in their benefits and if taken from a DC scheme the member will see a reduction in their pot value.
CETV – Cash Equivalent Transfer Value. The CETV is the amount a DB scheme will give to a member who requests to leave the scheme. It is supposed to represent the value of the benefits given up. It is important to note that the CETV will change, going up and down depending predominantly on interest rates. The CETV is calculated by looking at what amount would be needed as a lump sum for an individual member to maintain an equal level of benefits once they move to a private pension.
Some assumptions have to be made about the potential investment return when they are calculating the CETV. The result of this is that if interest rates are low CETV values will usually be higher. The average ‘multiplier’ for a CETV is 20 times, so the lump-sum is 20 times the promised benefits. For example, a member wants to leave his DB scheme that is promising him an income of £25,000. The scheme offers £500,000 as a lump sum, which is 20 times the promised benefit. Some schemes will offer a CETV that is as high as 40 times the promised benefit. Most schemes will give members a CETV on request for free every 6 months. The value will typically expire within 3 months and a new one will need to be requested.
LTA – Lifetime Allowance. The LTA is the maximum amount that a pension can grow to without being taxed. This amount is currently £1,073,100. Anything over this amount is taxable at 55% if taken as a lump sum or 25% if taken any other way. It may be possible to apply for LTA protection that could increase the threshold to £1.25 million.
PPF – Pension Protection Fund. The PPF was set up to protect members of schemes that become insolvent. It is funded by all the schemes that are still solvent that would fall into the PPF if they became insolvent.
BCE – Benefit Crystallisation event. A test usually has to be carried out each time benefits are taken from a registered pension scheme, to make sure the tax charge is applied if the lifetime allowance is exceeded. The occasions when this test is carried out are called benefit crystallisation events (BCE).
Who Should I Speak To About My Pension?
In all instances advice should be sought from a professional adviser. If you are living overseas an adviser who is experienced in offshore finance may be able to provide more rounded advice.