The latest figures from the British Embassy in Madrid suggest that are as many as 800,000 British expats living in Spain for all or part of the year. Of these, 75,000 are retired and have moved there permanently.
If you are a UK pension policyholder and have settled, or intend to settle, in Spain, you should consider transferring to a QROPS (Qualifying Recognised Overseas Pension Scheme).
QROPS are pension vehicles approved by HM Revenue & Customs (HMRC) to facilitate the transfer of UK pensions overseas. A list of recognised schemes can be found on the HMRC website.
Since their introduction in 2006, QROPS have become increasingly popular with retired expats in Spain. They are also common with Spanish nationals who have worked in the UK for a period and then returned to Spain.
Significant benefits can be obtained from transferring your pension into a QROPS. It is important, however, to consider both the pros & cons:
QROPS Spain Pros and Cons
- Ability to take a 30% lump sum free from UK tax after the age of 55
- Flexible drawdown facility
- Assets can be held and income drawn in a currency of your choice
- No requirement to purchase an insurance-based annuity
- The option to leave the fund tax-free to named beneficiaries after five complete tax years of non-UK residency
- Removal of the 55% tax charge applied to lump sums on death in the UK
- Access to a wide range of funds globally
- Consolidation of multiple UK pensions into one scheme, making them more cost-effective
- Protection of assets from creditors and divorce (It is harder for UK courts to take action to seize or lay claim to funds contained in a QROPS than in the case of a normal UK pension).
- Pensions with existing annuity arrangements can not be transferred to a QROPS
- Pensions that have already made distributions from Final Salary/DB schemes are not eligible
- UK State pensions can not be transferred to a QROPS
- Pensions may be subject to UK tax and scrutiny from HMRC for the first five years of non-UK residency
Five Year Rule
Where a policyholder has been a non-UK resident for less than five full UK tax years, the QROPS provider must report to HMRC all payments made to the policyholder.
When a policyholder has been a non-UK resident for less than five full and consecutive tax years, the QROPS provider must report all pension payment distributions to HMRC. In the meantime, the QROPS is treated as if it is still a UK pension scheme by HMRC.
The QROPS provider must report all pension distributions to the Spanish tax authorities (Hacienda) for the first ten years of non-UK residency.
Tax on QROPS at death
There are several scenarios to consider should an individual die whilst living abroad:
- If a death payment is made within the five-year reporting period, the QROPS trustees must report the payment to HMRC regarding the deceased member. After five full years of non-UK residency, 100% of the remaining fund should be available to beneficiaries free of UK tax.
- If an individual dies before age 75 within five full and consecutive years of becoming non-UK resident, the deceased’s pension will be treated under UK law. The previous tax charge of up to 55% on inherited pensions was replaced in 2015 by HMRC. The individual will now be able to pass on their remaining ‘defined contribution’ pension to beneficiaries as a lump sum free of UK tax, whether it is in a drawdown account or untouched as long as it is paid out in lump sums or is taken through a flexi access drawdown account.
- However, if the individual dies within five full and consecutive years of becoming non-UK resident, whilst 75 years of age or over, under UK law, beneficiaries would be taxed at their marginal rate on any draw down from the pension. Beneficiaries can also receive the pension as a lump sum payment, subject to a tax charge of 45%. There are plans to make lump-sum payments subject to tax at the marginal rate for the 2016-17 tax year.
The current lifetime allowance for Pension funds had been set at £1,073,100. Any amount transferred to a QROPS above this figure would be taxed in the UK at the marginal income tax rate.
The UK tax rate payable on pension savings above the lifetime allowance depends on how the money is paid to you. The tax rate is:
- 55% if the pension is paid as a cash lump sum
- 25% if distributions are made as pension payments or cash withdrawals when in Spain
Spanish residents must report income from a QROPS on their annual tax return. However, by declaring the pension income as an annuity in Spain, it is possible to benefit from favourable tax treatment. To this end, the QROPS trustees supply Spanish tax residents with a certificate confirming that the income distributed from the pension fund is a “temporary annuity”. When personal allowances are considered, treating the pension income as a temporary annuity invariably becomes an attractive proposition for a Spanish tax resident.
If you receive your pension lump sum whilst resident in Spain, it will be taxable in Spain. For further information on how the proceeds of QROPS are taxed, please visit our page on Taxation in Spain.
Which jurisdiction to choose
Once a decision has been made to transfer your UK pension to a QROPS, the next thing to consider is which jurisdiction your scheme should be located in.
Unfortunately, Spanish law does not recognise trusts; however, such structures are preferred to receive/protect UK pension transfers. It is important, therefore, to look for alternatives. The most popular choice in terms of jurisdiction for those living in Spain is Malta.
Malta offers several distinct advantages to British expatriates in Spain:
- It is a member of the European Union
- It has a reputation for being a robust and well-regulated jurisdiction
- Malta benefits from having a Double Taxation Agreement with countries such as Spain
These factors help simplify the transfer of UK pensions and the taxation of pension income. When an individual buys a QROPS, it is regarded as a Malta pension, not a Malta trust. The trust is an administration vehicle and is used as a way of protecting the policyholder’s rights. The duties of the trustees are thus important in terms of how they look after an individual’s affairs/invest money.
In the case of a Malta QROPS, pension income should be declared in Spain for those tax resident there.