Why having too much in UK pensions can prove costly
More Britons than ever are being penalised for holding too much money in pensions. Official figures reveal 40% more people paid UK ‘lifetime allowance’ tax charges for breaching the government’s upper limit of pension savings in the year following April 2016. This was a staggering 1,047% increase from 10 years before, when the allowance was far more generous.
With tax penalties as high as 55% – bringing in £110 million for the Treasury last year – make sure you are not caught unprepared.
Who is affected?
The lifetime allowance charge affects anyone who holds more than £1.03 million in combined UK pension funds (excluding the State Pension). While this may sound like a high threshold, it does not just capture the ultra-wealthy.
Once you factor in decades of pension contributions, compounding interest, investment growth and tax relief, the limit may be closer than you think. If you have several pensions, have been saving for many years or have a generous company pension, you may even have exceeded the allowance without realising it.
For ‘final salary’ (defined benefit) pension schemes, the usual measure is 20x the annual income due plus any lump sum payable. However, this is not always straightforward, so you should check your position with your provider or pension adviser.
Breaching the allowance
Many people only become aware of exceeding the limit when they come to take their money out, technically known as a ‘benefit crystallisation event’.
Anyone with combined UK funds over the £1.03 million cap will face 55% tax penalties on lump sums, or 25% when accessing benefits as income or transferring pension funds overseas. This applies even if you are non-UK resident (including those with non-habitual residency in Portugal) and is on top of any other tax payable.
HM Revenue & Customs (HMRC) will also automatically test where you sit within the allowance when you turn 75, and finally on death.
Without effective planning, this can clearly have costly tax implications for you and your heirs, wherever you are resident.
How can you reduce your exposure?
While it is possible to obtain ‘protection’ from HMRC to secure a higher limit, be aware that strict conditions apply.
If your UK pension funds come under the lifetime allowance and you are resident in an EU/EEA member state such as Portugal, you can currently transfer to an EU/EEA-based Qualifying Recognised Overseas Pension Scheme (QROPS) completely tax-free (otherwise a 25% ‘overseas transfer charge’ usually applies). However, many expect the UK government may change the rules with Brexit, so there may be limited time to transfer without tax penalties. Once in a QROPS, funds are outside the scope of the lifetime allowance.
Alternatively, expatriates could take UK pensions as cash and reinvest into a tax-efficient arrangement for their country of residence. Before making any pension decisions, take extreme care to determine the most suitable approach and avoid pension scams.
Note that if you have already exceeded the lifetime allowance, transferring to a QROPS will trigger the 25% excess charge on anything over the limit. Take, for example, a pension fund of £2 million with HMRC lifetime allowance protection of £1.5 million. The excess transferred funds will attract a one-off tax charge of £125,000 (£500,000 x 25%) but would never be liable for these penalties again.
If you instead transferred to a UK scheme, like a Self-Invested Personal Pension (SIPP), you would not trigger immediate taxation but the funds would remain liable – with future charges increasing as funds grew. The 25% or 55% lifetime allowance penalties would become payable whenever you take benefits, and would also apply to any heirs inheriting the pension.
Although you would invite an immediate 25% tax bill when transferring funds over £1.03 million to a QROPS, you could subsequently access your money – however you wished and in your preferred currency – without further UK taxation. Your funds would also be free to grow without incurring higher penalties, and you could unlock more flexibility and tax-efficiency when passing pensions on to chosen heirs.
Reviewing your options
Even if your pension savings are within the allowance or you are not yet ready to access them, it is a good idea to review your situation. While your pension funds continue to grow, the lifetime allowance limit is only set to increase with inflation each year, so you could potentially avoid unnecessary taxation by taking steps now.
With pensions, it is vital to take personalised, regulated advice to establish what is suitable for your situation, goals and risk profile. Ensure your adviser is registered with the UK Financial Conduct Authority (FCA) and has the cross-border experience to understand the interplay between UK taxes and those in your country of residency. They can help you explore your options and take advantage of tax-efficient opportunities to secure a comfortable retirement, wherever you live.
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; individuals should seek personalised advice.
By Dan Henderson
Dan Henderson, Partner of Blevins Franks, is a highly experienced financial adviser, specialising in retirement, investment and succession planning. He holds the Diploma for Financial Advisers and advanced CII qualifications in pensions and investment planning.