Taxes for expats in Spain are levied on anyone who spends more than 183 days per year there. Many people manage their affairs in such a way that they maintain tax residence in their home country by ensuring that the 183 day limit is not breached. Some keep their fingers crossed, hoping the spotlight does not shine on them despite their exceeding the limit. Fear of perceived higher rates of Spanish taxation is real, particularly for those who also live in lower taxed countries. It is therefore understandable that such individuals try to avoid unnecessary taxation.
Brexit may create further potential issues for those who are either planning to move to Spain, or who realise that it is now time to become fully tax resident. If, for example, someone does spend more than 183 days a year in Spain, but is not registered with the tax authorities, and relies on the European Health Insurance Card (EHIC) for medical treatment, the only solution might be to purchase private health insurance at considerably higher cost.
This means that any financial benefits of retaining home country tax status will inevitably be eroded. Spanish health care is generally very good, and local health insurance premiums reasonable, even in the case of taking private cover.
Taxes for expats
The good news is that Spanish tax doesn’t have to be as pernicious as expected. As with all mature taxation systems in the world, there are ways in which certain taxes for expats can be legally avoided with the correct financial planning strategy. Making sure your money is based in the most tax advantageous environment is everyone’s right. Not doing so may appeal from a philanthropic viewpoint, but isn’t necessary. Tax can, in effect, be optional in certain circumstances.
Pensions and taxes for expats
Brexit is also proving to be an issue for British people who receive a Sterling pension. Nothing can be done about state pension entitlement, as this has to be paid in pounds. There are however various options that everyone should consider, if in receipt of a company or private pension.
Most pension schemes offer a choice between taking a ‘full pension’, or a lump sum and reduced income. This applies to defined benefit (salary related schemes) and defined contribution plans. Defined benefit schemes calculate the lump sum differently to defined contribution plans, however the intention is to provide rough equivalence. It’s important to check the details of your scheme and how the calculation is made.
A general financial planning opportunity is available for holders of both types of scheme. Consider the example of someone who is offered either a full pension of £25,000 or a reduced pension of £20,000 plus a pension commencement lump sum of £100,000. In this instance the person is, or is about to become, Spanish tax resident and seeking to reduce his/her tax liability.
If this individual were to take the full pension of £25,000, it would be taxed in accordance with Spanish income tax rates. After a fairly meagre annual allowance of €5,550 for those under age 65, the remainder would be taxed at a starting rate of 19%, rising on a progressive basis to 30% (see table below):
- Up to €12,450: 19%
- €12,450–20,200: 24%
- €20,200–35,200: 30%
- €35,200–60,000: 37%
- More than €60,000: 45%
This is a relatively simple example. However, it does illustrate that by taking the reduced pension of £20,000 and accompanying lump sum, taxable income would be below the 30% threshold. This, of course, means less taxes for expats.
What to do with the pension commencement lump sum
The next question is what to do with the lump sum? The structure of the investment vehicle is important in this case. If placed in property, a bank account or share portfolio, income would be taxed at 19% (perhaps more). The capital could also be subject to Capital Gains Tax (CGT) and/or Wealth Tax. This means that the benefits of taking the lower pension would be somewhat reduced, or even eliminated entirely.
The answer is to invest in a Spanish Compliant Insurance Bond (SCIB). If no income is withdrawn, there are no tax consequences. CGT and Wealth Tax which would be payable according to the growth on other investments are not applicable, as a SCIB is one of the few exempt structures available.
If income is withdrawn, tax rates are surprisingly generous. Full details can be found here. The example shows that making income withdrawals from a SCIB rather than other investments, leads to a dramatic reduction in taxes for expats.
A SCIB can also be invested in Euro denominated funds. This would help reduce future currency risk exposure and create a natural hedge against fluctuations in the Sterling:Euro rate. If Sterling rises against the Euro, income will rise. If it falls, the Euro investment will go some way to mitigating adverse effects.
The SCIB is also a highly effective way of managing income requirements for those who don’t have high pensions, but do plan to use capital in order to provide income in retirement.
Exploring all options available is therefore essential when planning one’s retirement income and tax position. Where tax is optional, you should seek to take advantage, as in many areas it is unavoidable!