One key outcome of March’s UK Budget was that the pensions lifetime allowance (LTA) was frozen at its current level for at least the next five years. This measure is estimated to push an extra 10,000 people over the threshold, netting the Treasury £990 million by 2026. With LTA tax penalties as high as 55%, make sure you are not caught unprepared.
What is the lifetime allowance?
Since 2006, the UK government has capped how much you can hold in combined pension benefits without paying extra tax. Originally £1.5 million, the LTA peaked in 2011 at £1.8 million before gradually dropping to £1 million in 2016. Tracking inflation since then, the Budget cancelled this year’s scheduled increase, freezing the LTA at £1,073,100 until at least 2026.
Who is affected by the LTA?
While the current lifetime allowance of £1,073,100 sounds high, it does not just capture the ultra-wealthy.
All UK pension benefits outside the State Pension are counted, including everything accumulated over a working lifetime. After decades of pension contributions, compounding interest, investment growth and tax relief, the limit may be closer than you think.
For ‘final salary’ (defined benefit) pension schemes, the usual measure of value is 20x the annual income due. Generally, this will mean those with pensions worth £53,655+ a year would be affected today.
What are the LTA penalties?
Once total pension funds exceed the allowance limit, extra tax is payable whenever you access your money (a ‘benefit crystallisation event’). How much you pay depends on the way funds are withdrawn – rates are 55% for lump sums and 25% for income or transfers to an overseas pension. So at best, the cost of being over can be a quarter of your funds, at worst: over half. Note that this is on top of any other tax payable.
Being non-UK resident offers no protection. Usually, Portuguese residents are not liable for UK taxes on British pensions (except government service pensions). However, for anyone over the allowance, these rules do not apply – the LTA tax is applied in the UK first and cannot be claimed back, even for those with non-habitual residence (NHR).
How can you check your LTA position?
Calculating how much of your allowance you have used is not always straightforward, especially for final salary pensions, so check your position with your provider or pension adviser.
HM Revenue & Customs (HMRC) will first test your allowance status when you start drawing your pension, then every time you access funds and when you turn 75. If you die before 75, any lump sums paid to your beneficiaries will also be subject to the LTA test and subsequent tax penalties.
How can you protect your pensions?
While it is possible to obtain ‘protection’ from HMRC to secure a higher limit, strict conditions usually apply, so take guidance.
Expatriates have the option of transferring UK pension funds to a Qualifying Recognised Overseas Pension Scheme (QROPS). If you transfer one or more UK pensions into a QROPS and your total benefits are under £1.073 million, you will not face LTA taxes on the transfer. However, make sure the QROPS is within the European Economic Area (EEA), otherwise you would still lose 25% through the ‘overseas transfer charge’.
Once in a QROPS, funds are out of reach of LTA penalties, no matter how much you have or how you access it. A suitable QROPS can also provide tax-efficiency, currency flexibility and estate planning benefits.
An alternative option is to explore taking your UK pension as cash and reinvesting it into a tax-efficient Portuguese-compliant arrangement. Again, this can unlock other benefits not usually available with UK pensions.
Reviewing your options
Before making any major pension decisions, it is crucial to take regulated, personalised advice to avoid pension scams and determine the most suitable approach for you.
What can you do if you are already over the limit? While you would trigger an immediate 25% LTA charge on a QROPS transfer, the funds become immune to further penalties. 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% LTA penalties would then become payable whenever you take benefits, also applying to any heirs inheriting the pension.
If you are over or close to the threshold, consider acting sooner rather than later. Your pension funds should continue to grow while the lifetime allowance remains frozen, so you could potentially avoid unnecessary taxation by taking steps now.
Even if your pension benefits are within the allowance or you are not yet ready to access them, it is sensible to review your situation. A regulated adviser with cross-border experience can help you explore your options and take advantage of tax-efficient opportunities to help secure a comfortable retirement in 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 Adrian Hook
Adrian Hook is a Partner of Blevins Franks in Portugal and has been providing holistic financial planning advice to UK nationals in the Algarve since 2008. He holds the Diploma for Financial Advisers (DipFA) and is a member of the London Institute of Banking and Finance (LIBF).