If you have spent years saving into a UK pension, recent changes could put you in the firing line for up to 55% taxation. Expatriates in Portugal, however, can take advantage of opportunities to safeguard their pension funds.
The lower lifetime allowance
A decade ago, the UK government introduced a ‘lifetime allowance’ to limit how much you can hold in pensions without paying extra tax. Having gradually fallen from its 2011 high of £1.8 million, in April it was slashed to £1 million.
While originally designed to mostly tax high earners, this latest reduction is affecting more people with modest salaries. In 2015/16, the Treasury collected 62% more than the previous year from those breaching the allowance. Now that another £250,000 has been shaved off, more people than ever are likely to be caught out.
How could it affect you?
Anything over £1 million in combined UK pension savings may be taxed at 55% when you access it or pass it on after death as a lump sum, or 25% if you take it as income.
For pension funds worth £1.5 million, this generates a £50,000 tax charge on income and a hefty £275,000 on a lump sum, on top of the tax payable on anything under the threshold.
You are liable for these taxes whether you are a British resident or not. Usually, UK pension income for Portuguese residents is paid gross in the UK (except government service pensions), then taxed only in Portugal thanks to the double tax agreement. For non-habitual residents, it is possible to pay no tax on UK pensions at all. However, for those over the lifetime allowance, these rules do not apply – the excess is taxed in the UK first and cannot be claimed back.
Will you be caught out?
While £1 million sounds like a lot, you could go over the threshold without realising it. The allowance applies to all pensions except the State Pension, and counts everything accumulated over a working lifetime, including contributions from you and your employer plus investment growth. It can therefore be punitive for financially prudent people who have been saving all their working life.
Even if your ‘defined contribution’ pension reaches £1 million, in this environment of low interest rates and unsettled stock markets, that may only provide a retirement income of £21,000 a year.
This presents a dilemma – if you want your pension to provide an adequate retirement income, you may need to exceed the lifetime allowance and suffer higher taxation. Expatriates could consider transfer options that may boost retirement income in a more tax-efficient way.
Checking your allowance
Pensions are complex, and calculating your lifetime allowance is no exception. Every time you access your funds – a ‘benefit crystallisation event’ – the value is added up and measured against the allowance. This includes taking an annuity, lump sums – during lifetime and in some cases on death – and transferring your pension. Once that balance exceeds the limit, you pay the extra tax.
Even if you are under the limit when you start drawing benefits, remember your pension funds will grow over time and years of investment growth may tip you over the limit.
It is possible to secure a higher limit by applying for lifetime allowance protection from HMRC. However, this usually has strict conditions attached, so guidance is advised.
Finding your best approach
Expatriates can transfer UK pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS) to avoid lifetime allowance penalties and receive more tax-efficient benefits. However, regulated advice is crucial to determine whether this approach is suitable and avoid pension scams.
If you transfer one or more pensions into a QROPS totalling under £1 million, you will not be liable for UK tax, otherwise it will be 25% on the excess. Once in a QROPS, however, your funds are out of reach of further lifetime allowance charges. You may be better off transferring and paying any tax charges now before your funds increase in value and attract further taxation.
Another option is to take your UK pension as cash and reinvest into a tax-efficient Portuguese compliant arrangement. Again, take regulated advice to protect yourself from fraud.
If you decide transferring is right for you, now may be the time to act. There is speculation that the UK government will introduce an ‘exit tax’ on pension transfers for non-residents. If this happens post-Brexit, there may be a limited time to transfer without penalties.
Pensions are often the key to financial security throughout retirement. Make sure you take the right action for your individual circumstances while considering any Portuguese and UK tax implications.
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual is advised to seek personalised advice.
By Gavin Scott
Gavin Scott, Senior Partner of Blevins Franks, has been advising expatriates on all aspects of their financial planning for more than 20 years. He has represented Blevins Franks in the Algarve since 2000. Gavin holds the Diploma for Financial Advisers. | www.blevinsfranks.com