First, we need to have a look at the old rules.
Individuals who transferred UK pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS) needed to be aware of the impact of the Lifetime Allowance (LTA) on their pension savings. The option of applying for Lifetime Allowance protection also had to be considered.
QROPS, Lifetime Allowance and Benefit Crystallisation
A transfer from a UK-registered pension scheme to a QROPS was considered to be a Benefit Crystallisation Event (BCE). When an individual crystallised their benefits to take a pension commencement lump sum or to facilitate the withdrawal of income from their pension capital, there was a test on the value of the crystallised savings against their LTA.
Over the years, we have witnessed a steady erosion of the standard lifetime allowance threshold from the high of £1.8m in the 2010/11 tax year. The LTA was lowered to £1.5m for the 2013/14 tax year, £1.25m for 2014/15, and then reduced to £1m in April 2016.
What was the Lifetime Allowance for a QROPS transfer?
The limit of £1,073,100 was the maximum amount of pension saving you could build up before triggering the Lifetime Allowance. Once the value of total UK pensions exceeded that limit, an individual would be subject to a tax charge of up to 55% on any BCE upon retirement or death.
How could I avoid lifetime allowance tax charges?
The transfer of your UK pension to a QROPS would arrest the value, including growth on your LTA, at the current value.
Expats wishing to access their retirement plans will save tax over the longer term by transferring their UK pension into a QROPS, therein crystallising the benefits. The net result could be:
- An increase in the available pension commencement lump sum that is tax-free from any future crystallisation
- Reduced likelihood of suffering a Lifetime Allowance tax charge on the future value of their pension fund whenever they draw on those untouched pension savings
Individuals who worked for some time in the UK in senior positions tended to have reasonably large pension pots. Many who were nearing retirement already had fund values of circa £1m. Younger executives may also have been on the way to securing such a figure.
Could I protect my Lifetime Allowance?
It may have been possible to protect your pension savings' Lifetime Allowance from the 2016 reduction, and those with pension pots close to the LTA limit should have considered transferring to a QROPS for the following tax planning purposes:
- By transferring to a QROPS, the Lifetime Allowance is immediately suspended
- The value of your pots at that instance will be registered with HMRC, and will not increase from that point unless and until you become UK resident again and resume contributions to a UK pension
How to claim LTA Protection at 2016 levels
The £1,073,100 LTA limit had ‘real teeth’ and will catch a lot of pensioners now and into the future. Tax will be payable at 25% of the excess in the case of benefits drawn as a taxable income stream, or 55% for lump sum benefits. However, there were ways to either reduce or avoid this tax. It was possible to apply for Lifetime Allowance Protection on pension savings from the 6 April 2016 reduction of the standard lifetime allowance, when it was reduced to £1 million. The 2 available forms of protections were:
- Fixed Protection 2016
- Individual Protection 2016
Although the LTA has been abolished, it’s worth noting how these protections worked.
Fixed Protection 2016 (FP2016)
Provided there were no further contributions to Defined Contribution (DC) pension schemes, those with total pensions of more than £1,073,100 could apply for FP2016. In so doing, their assets were protected at the 2016 limit of £1.25m.
The same applied to those with Defined Benefit (DB) plans, excluding any future inflation increase. For DB schemes, you calculate the total value by multiplying your expected annual pension by 20.
The calculation is based on the 'full pension' before any reduction for lump-sum benefits.
Individual Lifetime Allowance Protection 2016 (IP2016)
IP2016 was available to anyone whose total DC pension entitlement as of the 5th April 2016 is more than £1m, with a cap at £1.25m.
The difference between IP2016 and FP2016 is that it was still possible to contribute to pensions after claiming protection.
Individuals must pay tax on money taken from pension savings that exceed the protected lifetime allowance.
Similar rules apply for DB pensions. Individuals with full pension benefits of over £1,073,100 can apply for protection. Members can continue contributing to their fund; however, total pension values are capped at £1.25m.
Impact on Lifetime Allowance of transferring into a QROPS
Assuming Lifetime Allowance protection has been granted, and your pension entitlement was still higher than £1.25m, a transfer to a Recognised Overseas Pension Scheme (ROPS) will be subject to a 25% tax on any excess.
In many cases, tax on lump sums in your chosen country of retirement may be considerably less (or even zero in some cases) than the punitive 55% applied to the excess over the LTA on UK pensions.
As such, whether you have to pay tax or not, it is best to commute the whole pot as a drawdown income stream, pay the 25% on the excess, then withdraw the Pension Commencement Lump Sum (PCLS) when in situ.
In other cases where the total protected pension pot is within the £1.25m limit, it would usually be better to take the PCLS while still UK tax resident, then draw down the income stream after transfer to a QROPS/ROPS.
QROPS members who resume/take up UK tax residency can receive a PCLS at the level of 25%, which will not be subject to UK tax, provided the fund has not entered drawdown.
Once the member commences income drawdown, he/she forfeits all rights in the future to PCLS, irrespective of where he/she is tax resident.
The various QROPS/ROPS jurisdictions have different rules for drawdown. It is, therefore, essential to choose the right one for your needs. Malta is currently the preferred choice within the EU, as it offers pension freedoms similar to those available in the UK.
The Lifetime Allowance was then abolished. What did this mean?
No one expected the abolition of the Lifetime Allowance in the 2023 Budget. Rumours always abound within the industry the week before, but major structural changes rarely happen.
The industry expected the limit to be restored to £1.8m, but the Chancellor went even further, completely abolishing the LTA.
The rationale was to encourage highly paid health professionals to remain in work longer.
As a result of certain anomalies, it had become pointless to carry on due to a combination of technical factors which unfairly penalised doctors, consultants, and other specialists in the health service.
The Lifetime Allowance, represented by the amount of pension savings which could be built up before a tax charge was applied, had been gradually reduced from the high of £1.8m in 2010/11 to £1,073,100.
Low interest rates inflated Defined Benefit ‘Cash Equivalent Transfer Values’ well beyond the assumed 20 times full annual pension level, giving members a very attractive choice when considering moving their DB pension into a Defined Contribution environment.
Interest rates are now significantly higher, which has resulted in much lower CETVs and notably reduced numbers of DB transfers.
When interest rates were low, it wasn’t uncommon to see CETVs at 40+ times the expected full pension. So, although the DB Lifetime Allowance liability was calculated at 20 times pension, CETVs were considerably higher.
For example, a pension of £30,000 per annum would be tested against the Lifetime Allowance at 20 times £30,000 - £600,000. This was well below the Lifetime Allowance limit, and a CETV of perhaps £1,200,000 might be offered.
By transferring to a DC scheme, only 60% of the LTA would be crystallised, despite the actual amount being over the limit.
Additionally, for those who live outside the UK, it was possible to transfer to a QROPS and eliminate any present and future LTA liability.
Many took advantage, and QROPS have proved to be a valuable tax planning vehicle for expats and internationally mobile people.
QROPS and the abolition of the Lifetime Allowance
Does the abolition of the LTA mean QROPS are essentially redundant now? At the time, I would have argued no. There are many other benefits of transferring UK pensions into a QROPS.
More changes were, however, afoot. Whereas transfers to QROPS within the EU/EEA were exempt from the Overseas Transfer Charge, this has subsequently been revised, and only transfers to countries in which the QROPS is based and bona fide employer-sponsored schemes are now free of the OTC.
New Lifetime Allowance rules
Just when the pension sector felt it could move forward, it faced a set of new Lifetime Allowance rules. In the 2023 budget, the Chancellor announced the abolition of the Lifetime Allowance (LTA). The legislation was supposed to be effective immediately, but as royal ascent wouldn’t be completed until February 2024, the pensions industry had been in flux in the interim.
Royal ascent was granted, so there will be no more LTA from the new 2024/25 tax year on the 6th of April - or so we thought.
As is often the case, the devil is in the detail, and the rule of unintended consequences, which seems ever-present when pension legislation is changed, needs to be considered.
What has changed?
What are the new Lifetime Allowance rules, and how do they apply to Non-resident SIPP transfers? As things stand, some SIPP transfers may still be liable for Lifetime Allowance taxation.
The most important changes to the new legislation relate to how lump sum pension payments and lump sum death benefits will be taxed going forward. Two new acronyms have entered the lexicon – Lump Sum Death Benefit Allowance (LSDBA) and Lump Sum Allowance (LSA).
Tax free withdrawals are capped at the maximum available under the old LTA limit of £1,073,100, which equates to £268,275. Higher lump sums are allowed for those with existing Lifetime Allowance protection in place. This means those lucky enough to hold 2012 Fixed Protection of £1,8m can take a lump sum of up to £450,000.
The same applies to Lump Sum Death Benefits. The maximum that can be paid tax-free on death before age 75 will be limited to the old LTA or the protected amount. After age 75, beneficiaries will be taxed at their marginal rate. Therefore, it is very important to ensure potential beneficiaries are aware of the regulations and options available to them.
Beneficiaries in receipt of pension death benefits after age 75 of the policyholder don’t have to take the whole amount in one go and suffer the huge tax liability this would incur. Most pension plans will allow the beneficiary to receive the payments over a period of time by triggering Drawdown, purchasing an annuity, or deferring payment completely until their retirement by simply assuming ownership of the pension plan. Note that the pension company has to be informed of the option taken within two years of the plan holder’s death.
QROPS and the new Lifetime Allowance rules
QROPS transfers are a case in point. Whereas we were led to believe that QROPS transfers wouldn’t attract the LTA after the 6th of April 2024, it appears this isn’t the case.
Furthermore, we’ve been introduced to another new acronym: the Overseas Transfer Allowance (OTA). This allowance applies to QROPS transfers and is limited to the old LTA of £1,073,100. Any transfers in excess of this are taxed at 25%.
There are kinks in the legislation whereby someone who previously went into drawdown could be double taxed; HMRC and the Government are working on ironing out the wrinkles.
This doesn’t mean QROPS transfers are now unworkable, though. In fact, there are several scenarios in which they are still as effective as ever.
For example, if someone has a large pot currently of lower value than the old LTA, no OTA will apply, and future growth will remain outside the OTA. If there is no immediate need to release funds from the pension, this benefit should increase as the fund grows.
Death benefit taxation will then relate to a combination of the country where the QROPS is based and the individual’s tax residence. If we also consider that a new Labour Government could reintroduce the LTA, it may be best to release funds sooner rather than later.
Malta QROPS for non-UK residents who are tax resident in an EU country will therefore be subject to the inheritance and succession rules of the country where they are tax resident, which may be more beneficial than the UK.
About Phil Loughton
AXIS Financial Consultants
He has worked in the financial services industry for 35 years and is an expert in expatriate retirement planning.
