How much are your pensions worth? The answer is not always clear, especially if you have accumulated several pensions over your lifetime. While it may seem beneficial to hold as much as possible – the bigger the better to finance your retirement – having too much in UK pensions can actually expose your funds to eyewatering tax penalties. And, as with any financial arrangement, the way you structure and access your pension benefits can have a significant impact on your tax bill.
For UK expatriates in Portugal, it is sensible to explore the options and how to protect pensions from unnecessary taxation, especially as full Brexit draws near.
The UK’s lifetime allowance (LTA)
The LTA is the maximum you can hold in combined UK pension benefits before extra tax penalties of 25% or 55% apply. The current limit – £1,073,100 – may seem high, but many people are closer to it than they realise.
All pension benefits (excluding the State Pension) count towards the LTA, often including decades of contributions, compound interest, investment growth and tax relief.
For defined benefit (‘final salary’) pension schemes, the usual measure of value is 20x the annual income due. This means defined benefit pensions worth £53,655+ a year may go over today’s limit.
What are the LTA penalties?
Once the allowance is breached, penalties are payable whenever you access funds or pass them on to heirs (‘benefit crystallisation events’). Rates are 55% for lump sums and 25% for income and transfers – this is on top of any other tax payable, even if you are non-UK resident. Without effective planning, this can clearly have costly tax implications for you and your heirs.
Calculating how much of your allowance you have used is not always straightforward, so check your position with your provider or pension adviser. HM Revenue & Customs (HMRC) will automatically test where you sit within the allowance when you turn 75, whenever you take money out, and finally on death.
How can you protect your pensions?
It is possible to secure a higher limit by applying for LTA ‘protection’ from HMRC, but take care as strict conditions can apply.
Expatriates are able to transfer one or more UK pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS). Although you would pay 25% on anything transferred over the LTA, once in a QROPS, funds are immune from future LTA penalties. A QROPS can also provide ongoing tax efficiency, income and currency flexibility, and estate planning advantages. However, similar benefits could be achieved by reinvesting cash from UK pensions into alternative Portuguese-compliant arrangements, so take personalised advice to establish what’s right for you.
The overseas transfer charge (OTC)
Although LTA charges will only apply to a QROPS transfer if total benefits are over £1,073,100, beware another potential tax trap. If you are EU resident, your QROPS must be based within the EU/EEA or you would instead lose 25% of funds to the UK’s ‘overseas transfer charge’. With no UK-approved QROPS in Portugal, take specialist advice to navigate suitable options and avoid this unnecessary tax.
Note that the 25% LTA tax applies to funds over the limit only, whereas the 25% overseas transfer charge is made against the entire amount.
After the Brexit transition period ends in December, the UK has scope to extend the OTC to include all EU/EEA transfers. As such, there may be limited time to transfer without losing a quarter to UK taxation.
What if you are already over the LTA?
Excess funds transferred to a QROPS trigger an immediate 25% LTA tax bill, but 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.
If you instead transferred to a UK scheme, like a Self-Invested Personal Pension (SIPP), you could do so tax-free but would remain liable to LTA penalties whenever you take benefits or pass them to heirs.
Reviewing your options
Even if your pension benefits are within the LTA or you are not ready to access them, it is sensible to review your situation. Pension transfers can take several months – and the rules could change post-Brexit – so explore your options sooner rather than later, especially if you are close to the limit. While your pension funds are free to grow, the lifetime allowance is only set to increase with inflation each year so you could potentially avoid unnecessary taxation by taking steps now.
It is vital to take personalised, regulated pensions advice to avoid pension scams and establish the most suitable approach for your situation, goals and risk profile. An adviser with cross-border expertise is best placed to outline your full range of options and tax-efficient solutions for Portugal.
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 is a Partner of Blevins Franks in Portugal. A highly experienced financial adviser, he holds the Diploma in Financial Planning and advanced qualifications in pensions and investment planning from the Chartered Insurance Institute (CII). | www.blevinsfranks.com