By STUART RITCHIE
Your pension is one of your most important financial assets. Any decision to transfer it should not be taken lightly, and for expats, there are particular aspects to consider. With this post, I hope to provide some clarity on the subject.
To start: a case study
Here’s a real-life story of a global citizen, just like you, who managed to turn his finances around in the nick of time. Most high-earning executives where I live in Dubai regularly get calls from financial salespeople, eager to give unsolicited advice on the best thing to do with your pension. They’re typically very friendly and make big claims when it comes to how much you can save in tax, and unfortunately, it’s easy to be taken in by them.
The client in this case study, John, an engineer based in Dubai, was one of them. Luckily, he came to us at AES for a second opinion. At the time John had a QROPS valued at £800,000. The salesperson who had phoned John recommended he and his wife transfer into two individual QROPS schemes. His pensions had been structured as a QROPS, with an underlying bond as the platform. A bond is a tax wrapper, and so is a QROPS or SIPP. Having a tax wrapper within a tax wrapper can complicate financial plans. In this case, it made him liable to unnecessary charges. These opaque charges funded the commissions of the salesperson. Moreover, the QROPS was expensive and ineffective. John now lives in the UK, so it would potentially make sense to move his pension back to a UK-based, low-cost SIPP. However, we recommended a different solution – for him to retain the QROPS wrapper for the following reasons:
- Since John planned to retire abroad, it was more beneficial to retain his QROPS status, as it allowed him to pay out a pension income or capital in different currencies.
- He could draw his pension income free from UK income tax when he retired outside of the UK. If he lived outside the UK long enough, he could draw a higher tax-free initial sum of 30% in retirement, as opposed to 25% (SIPP).
- He was in his early 50s and by the time he reached his expected retirement age of 65, he would've grown to exceed the lifetime allowance of £1.073 million.
- If he transferred his pension back to a UK SIPP, he would be taxed 55% on amounts that exceed £1.073 million. Finally, he had limited capacity to make future contributions to his pension and obtain tax relief, as he was no longer working.
We advised him to retain his QROPS status and transferred him to a lower cost, higher quality provider. After which, we introduced a low-cost platform and removed the unnecessary bond tax wrapper. We then rebalanced his portfolio through a low-cost, evidence-based strategy. In this case, we reduced John’s ongoing charges by 3.48% per annum (or saving £27,840 based on a value of £800,000), whilst substantially improving his long-term investment performance. Perhaps far more importantly, our review allowed for the crafting of a tangible financial plan and investment policy to address John's anxiety and focus on his most cherished goals. Remember, there could be many potential solutions for you depending on your circumstances. Transferring your overseas pension is a huge decision. So, make sure you understand exactly what pension you have and its unique implications.
What’s the difference between QROPS and SIPPs - and should I transfer my pension?
You may have friends or colleagues who’ve transferred their pension into a SIPP or a QROPS - and perhaps you’re wondering whether you should do the same. Remember, pensions get quite technical, and the personal circumstances around your pension and retirement needs are unique. So, the safest course of action is always to seek expert help from a qualified professional adviser before taking any action.
What is a self-invested personal pension (SIPP)?
SIPPs are UK-registered personal pension schemes. They are defined contribution schemes (meaning only the contribution you make is defined - there is no guaranteed level of income at retirement). They are generally funded by an individual, and abide by UK legislation with regards to tax, and when and how they can be accessed. SIPPs have become very popular in recent years, driven by their relatively low cost - and the wide investment choice they offer. It’s important to remember though, that SIPPs are UK-based, so if you are living abroad the advantages of using them can be limited. For example, pension contributions in the UK to a UK-registered scheme receive tax relief of at least 20% per year. However, if you live abroad and are paying into a UK-based scheme, tax relief will only be available for the first five tax years of your non-UK residence. And you will also be subject to a cap of £3,600 per annum.
Like all UK pensions, SIPPs received a boost a few years back when new rules came into effect providing people with fully flexible access to their defined contribution pensions (including SIPPs). This flexibility simply means people can decide for themselves when and how they take their pension income, after the age of 55.
What is a Qualifying Recognised Overseas Pension Scheme (QROPS)?
QROPS are actually very similar to SIPPs, as they are defined contribution schemes, but they are based outside the UK. They can be based in any country around the world, and qualify as a QROPS as long as the scheme meets specific requirements set by HMRC. As mentioned, HMRC does not vet individual schemes – the scheme trustees notify HMRC of their existence and self-certify that the scheme meets the criteria. After this, the scheme will normally become “recognised” by HMRC, and will often (but not necessarily) be included on a list published on its website. QROPS are intended for people who are planning to, or have already left, the UK. The main difference between a SIPPs and a QROPS is the additional tax benefit a QROPS may bring to those living outside the UK.
QROPS and the lifetime allowance
One of the biggest benefits of QROPS is around something called the lifetime allowance (LTA). Under current UK legislation, you can only accumulate a tax privileged pension fund of up to £1.073 million, unless you apply for certain types of protection which can boost this to higher levels in some circumstances. This means pension savings above the LTA may be taxed at up to 55%. However, if you transfer your pension into a QROPS, it is tested against the LTA at the point of transfer, and not again thereafter. This means, if the value of your UK pension fund is close to the LTA, it may be worth considering a transfer into a QROPS to avoid being taxed on your pension savings above the LTA in the future.
"Should I transfer my UK pension?"
As well as understanding what SIPPs and QROPS are, it is vital that you understand the benefits of the type of scheme you currently have. There are two types of UK pension scheme – defined contribution and defined benefit. Defined benefit schemes are colloquially known as “gold-plated pensions.” They provide scheme members with a pension that is intended to be guaranteed. These schemes are becoming rare due to their cost - and if you have one, you should think very carefully before transferring from it. It is also now required - by law - that anyone considering a transfer from a defined benefit scheme worth more than £30,000, including into an overseas scheme such as a QROPS, must have taken financial advice from an adviser qualified to provide UK pension advice. Such an adviser has to be authorised by the Financial Conduct Authority.
7 things to keep in mind if you’re contemplating a pension transfer:
1. Spring Budget 2017: QROPS changes
On the 9th March 2017, some significant overnight changes occurred to pensions legislation, the most dramatic of which relates directly to those who wish to transfer their UK pension benefits to an overseas scheme, such as a QROPS. In summary, there is now a 25% tax upon transfer, levied at source by the UK trustee, unless one of the following conditions is satisfied:
- Both the individual making the transfer and the QROPS are in the same jurisdiction treating the EEA as a single jurisdiction for this purpose.
- The QROPS is a scheme in which the individual’s employer participates, and the employer is a multi-national.
This means that in some circumstances a QROPS is no longer a realistic option. It can also mean that additional specialist tax advice is required to determine whether a transfer is feasible. AES International has produced a detailed technical note describing how these changes affect QROPS. You can download it here.
2. What will my spouse and children get when I die?
With a defined benefit scheme, the death benefits provided to your spouse and children can be relatively poor. In some cases, especially if your children are older, you may find they receive nothing. By transferring into a defined contribution scheme – either a SIPP or a QROPS, you may be able to leave much more to your family when you die. In addition, it may be possible for the fund to “cascade” from one generation to the next.
3. Is my pension fund near the LTA?
As mentioned above, breaching the lifetime allowance could see your pension subject to high taxes. It may be worth considering moving your scheme overseas to avoid this happening. A QROPS may be suitable in this case.
4. How much tax will I pay on my income?
UK pensions are taxed, and in some cases, it may make sense to move your pension to a QROPS in the country you are living in, or to a “third party” QROPS jurisdiction. This depends on the terms of any double taxation agreement (DTA) between the country where your pension income comes from, and the country in which you are living. Claiming double taxation relief can be complicated, and if your pension income is paid from the UK, it may result in a procedure to reclaim tax deducted at source. The purpose of a DTA is to prevent pension (and other) income being taxed twice. But if there is no DTA in place, you could end up being taxed twice – in the country in which you are living, and where your pension is based. It is therefore of paramount importance that you take specialist tax advice on this point.
5. How will currency impact my pension income?
Currency is something that must be carefully considered. You may be able to exchange pension income into another currency, but the timing of an exchange could have a material impact on the size of your pension. Also remember that if your pension is paid from the UK, and you are living abroad, you will need to factor in an exchange to a local currency when working out your income.
6. I have a defined benefit scheme and would like to begin drawing my pension early, is this possible?
It’s generally possible to move the retirement date if you have a defined benefit scheme – this is set by the rules of the scheme, but subject to the minimum pension age set by the UK government, now 55. But, taking your pension earlier than the scheme pension age will normally bring with it quite a substantial reduction in pension. However, if you transfer the pension into a defined contribution scheme, such as a SIPP or a QROPS, you will be able to begin withdrawing income from age 55.
7. Will my pension savings perform better if I consolidate into a QROPS or SIPP?
It’s very common for people to have multiple pensions from time spent working at different companies, all with different schemes. It may make sense for you to consolidate your pensions to reduce costs and make your pension portfolio work more efficiently. Knowing whether to transfer your pension is arguably one of the biggest financial decisions of your life, and so it must only be done after taking advice from a fully qualified adviser. If you want to learn more, you can download AES's free guide.
STUART RITCHIE is Director of Wealth Advice at AES International, an evidence-based financial planning firm, based in Dubai, and serving English-speaking expats around the world.
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