Individuals considering the transfer of large UK pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS) should be aware of the impact of the Lifetime Allowance (LTA) on their pension savings. The option of applying for LTA protection should also be examined.
QROPS, Lifetime Allowance and Benefit Crystallisation
A transfer from a UK registered pension scheme to a QROPS is considered to be a Benefit Crystallisation Event (BCE). When an individual crystallises their benefits to take a pension commencement lump sum or to facilitate the withdrawal of income from their pension capital, there is a test on the value of the crystallised savings against their LTA.
Over recent years we have witnessed a steady erosion of the 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.
The current limit of £1,073,100 is the maximum amount of pension saving you can build up before triggering the LTA. Once the value of the total UK pensions exceeds that limit, an individual would be subject to a tax charge of up to 55% on any BCE upon retirement or death. The transfer of your UK pension to a QROPS would arrest the growth on your LTA at today’s value.
The relevance of QROPS and the Lifetime Allowance to you
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 an LTA tax charge on the future value of their pension fund whenever they draw on those untouched pension savings
Individuals who have worked for some time in the UK in senior positions tend to have reasonably large pension pots. Many who are nearing retirement will already have fund values of circa £1m. Younger executives may also be on the way to securing such a figure. Those with pension pots close to the LTA limit should consider 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
If you transfer to a QROPS, keeping your UK pot below the £1,073,100 LTA limit, your tax-saving potential going forward is almost unlimited!
How to claim your LTA Protection at 2016 levels
The current £1,073,100 LTA limit has ‘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 are ways to either reduce or avoid this tax. It is possible to apply for LTA 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 are:
- Fixed Protection 2016
- Individual Protection 2016
Fixed Protection 2016 (FP2016)
Provided there are no further contributions to Defined Contribution (DC) pension schemes, those with total pensions of more than £1,073,100 can apply for FP2016. In so doing their assets will be protected at the 2016 limit of £1.25m.
The same applies for 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 Protection 2016 (IP2016)
IP2016 is 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 is still possible to contribute to pensions after you claim 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.
How to apply
The UK government’s ‘department for work and pensions’ website offers useful information on how to apply for LTA Protection: LTA reduction
QROPS and Lifetime Allowance Protection: Tax planning opportunities
Assuming LTA protection has been granted, and your pension entitlement is 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 that 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.
Potential banana skins
UK rules regarding DB schemes are a little out of date in terms of the 20 times multiplier. Most DB schemes’ Cash Equivalent Transfer Values (CETV) are calculated at 30 times or more. This means that the actual CETV applied at retirement or transfer may be considerably more than expected. If an individual is still a long way from retirement, he/she should take this into account.
There is a need to be careful when comparing benefits from DB schemes with QROPS or DC transfers. Official Critical Yield (CY) calculations should have been updated following the pension freedoms legislation of 2015. The new rules still assume that an annuity is the only DC option; this has made CY assumptions almost irrelevant. In short, a CY rate is the investment yield required to equal any DB pension income prediction. As such, the analysis may suggest you need to achieve a 6% rate of investment return to equal your DB pension. The problem with this calculation is that there is an assumption that individuals will withdraw a low-rate annuity (of perhaps around 4% p.a.). In practice, however, and as a result of new UK pension freedoms, a lot of retirees would seek to draw down more than an annuity would permit, thus invalidating any CY calculation.
Moreover, as there is now no requirement to take an annuity, DC schemes have become more attractive in terms of passing wealth down through generations. Previously, a surviving spouse would receive a pension at 50% of the value; the remainder would be forfeit. In the new era, this is no longer the case.
LTA Protection is a relatively complex area of financial planning that requires scrutiny. If unsure about limits and how best to approach this issue, we recommend that you seek professional advice.
Pension funds are easy targets for UK governments wishing to raise revenue.; we have seen such ‘raids’ in the past. The current trend suggests that the government will lower the lifetime allowance limit below the present threshold at some stage. There is, however, always a window of opportunity for pension planning!
For further information about QROPS and the Lifetime Allowance, please download our free QROPS Guide