Pension particulars: what changes to legislation mean for UK expats

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Pension particulars: what changes to legislation mean for UK expats
Published: 23/01/2011 at 12:00 AM
Bangkok Post: Newspaper section: Spectrum
 
Over the past two years, there have been some changes to UK pension legislation that affect many expats. These do not relate to the UK government state pension for citizens, but rather to the private pensions of anyone who has worked in the UK.

In 2006, on "Pension A Day", the laws concerning UK private pensions were changed in line with the implementation of EU rules requiring all citizens to have freedom of movement of capital. Prior to that, if you worked at any time in the UK, you probably had a pension scheme that would have been deferred until your retirement, when you would be paid benefits. These benefits would be taxable in the UK as the income was generated in the UK.

Since Pension A Day, if you leave the UK, you may transfer your deferred UK pension offshore. You need to meet certain criteria, the first being that you do not intend to move back to the UK in the foreseeable future. If the transfer value of the pension in the UK is less than 1% of the lifetime allowance, you may actually claim a full refund of the value once you reach the minimum retirement age of the scheme or 55.

The current lifetime allowance is 1.8 million (87.85 million baht) but is being reduced to 1.5 million at the start of the next UK tax year, on April 6. So, if your transfer is currently, say, 16,500, it is below the current lifetime allowance of 1.8 million and you may reclaim your pension pot as a full refund under what is called the "triviality rule". Effective from April 6, the value would need to be less than 15,000 for you to claim a triviality refund. If you are uncertain about this, I suggest you seek professional help.

Many readers have asked me what the lifetime allowance means. In simple terms, it is the amount that you can contribute into your pension scheme and get maximum tax breaks. If your total pension pot exceeds the lifetime allowance, you would pay tax on the excess when you retire. If you were to withdraw this at retirement, this would be at the rate of 55% of a lump sum. If not, 25% tax would be payable on the excess prior to the investment going into the generation of a pension income for you. The specific rules on lifetime allowances are a little more complex than this but affect very few people. If you think you have a pension pot in excess of the lifetime allowance, you ought to be seeking professional advice on what to do about this.

There are two types of private pension schemes in the UK.
 
The first is a defined contribution scheme, sometimes known as money purchase.
Your employer contributes a fixed amount of your earnings into an investment that becomes yours when you retire. However, you are never allowed to simply be refunded the value of the investment. It must be used to generate an income to sustain you through retirement. This can be in the form of an annuity or a drawdown of income from your investment.

If you opt for an annuity, you actually sell your lump sum in return for an income stream. Annuities may have several features built into them. First, you may opt to have the income stream increased each year to keep up with inflation. You may also opt to have a survivor's pension built in after you pass away. There will usually be a minimum guarantee period for which the income will be paid. This could be, say, five years. If you die within that period of retiring, your estate will receive the income you would have been paid up to the end of the guarantee period.

So, if you had a guaranteed period of five years and you retired and then died three years after taking an annuity, your estate would receive the balance of two further years as a lump sum. Under new regulations to be introduced soon, the compulsory taking of an annuity at any age will be scrapped. However, annuities are still available and could be relevant to some members.

The second type of pension scheme in the UK is a defined benefit or occupational pension scheme.
 A fixed percentage of your salary is paid into a scheme and at retirement you are paid an annual pension calculated by reference to your years of service, your annual salary and an accrual formula.

Let's look at an example. If you worked for 30 years for a company with such a scheme and then retire, you would receive a pension based on 30 years of service divided by the accrual rate, which is usually 1/60th or 1/80th. If your salary had averaged 70,000 a year for the past three years and the accrual rate was 80, you would receive a pension calculated as: 70,000x30 years/80 accrual rate = 26,250 per year.

It would be common for a tax-free lump sum of 25% of the value of the pension pot to be paid to you immediately prior to pension payment. The annual pension would also be incremented by a related statistical figure such as the retail price index; inflation rate; or maybe a guaranteed increment. These schemes are very valuable and if you have one, you should be careful when you consider transferring it elsewhere.

Since Pension A Day you are able to transfer your UK pension to a Qualified Recognised Overseas Pension Scheme (QROPS). This has been discussed in several previous articles. However, there are changes being proposed that may affect you if you have not already taken action.

One proposal has been tabled that would disallow any member of a defined benefit scheme from transferring a pension to any other vehicle, effective from April 2012. This would also exclude transfers to a QROPS. So, if you are an expat and have been sitting on the fence about whether to get some advice about your scheme, it is probably wise that you start to do so now.

Remember that there are a number of major advantages with a QROPS and you need to carefully consider whether you wish to enjoy these.

First, if you leave your deferred pension in the UK when you draw the benefits, the pension would be taxable income wherever you live as it is considered income derived from the UK. Then there is the fact that when you die, your heir will receive a 50% pension, but thereafter there are no further benefits available to anyone.

In some cases there are lump-sum benefits available to beneficiaries and some clients have told me that UK inheritance tax is not payable on these benefits. However, they seem to overlook the fact that if they pass away prior to age 75 and have taken any pension benefits, or if they are over 75, a death benefit tax of 55% of the benefit is actually payable. True, this is not inheritance tax but it is still a tax.

If the pension pot was in a QROPS, there would be no UK tax payable on benefits drawn and there would be no inheritance tax payable on the residual estate left to your heirs. These two benefits alone are very substantial.

There are further advantages that been revealed recently, such as the fact that a UK-based pension is invested in and always paid in pounds. If your pension is transferred to a QROPS, you have the choice of diversifying currencies and thus the base currency of your income receipts.

For example, I had a client who transferred his pension to a QROPS and decided to diversify into several currencies including Australian dollars. Today, he is drawing income from that portion of his investment in Australian dollars and enjoying a similar exchange rate to the Thai baht as it was two years ago. Had he stuck with pounds, his income would have depreciated significantly as it has for many others.

There are further changes afoot for UK pension legislation and the way they may affect QROPS and I shall continue with these next week.