QROPS Pension Benefits
Since they were introduced in 2006, the popularity of QROPS (Qualifying Recognised Overseas Pension Schemes), an HMRC-recognised overseas pension, continues, alongside SIPPs, to grow amongst expatriates and individuals considering a move overseas.
The ‘Pension Flexibility 2015’ changes to UK pensions, have also had a limited but important impact on the 16 benefits of QROPS set out below.
Up to 30% Tax Free Lump Sums compared with 25% in the UK
When you start drawing benefits from a UK Pension scheme typically 25% can be taken immediately as a tax free lump. This is provided certain limits are not exceeded i.e. total pensions are not larger than the lifetime allowance (LTA) currently £1,000,000, unless you have secured one of the protection measures available. With a QROPS after the ten year reporting period (5 years before 6 April 2013) then the UK payment rules no longer apply and you will be able to take up to 30% as a tax free lump sum.
Testing against the falling Lifetime Allowance now
The LTA has reduced in real terms ever since 2010/11 when Alistair Darling saw it as a means of raising funds through this additional tax. The table below illustrates how it has fallen from its high at £1,800,000 to the low of £1,000,000.
If the LTA is exceeded the excess is taxed at 55% if taken as a lump sum or 25% if taken as income although there is still income tax to also be applied.
This makes it painful and extremely tax inefficient for pension holders who may exceed the LTA.
When a UK Pension Scheme is transferred to a QROPS its value is tested against the LTA at that point. As the pension has been tested against the LTA at that stage any future growth is then outside of the scope of the LTA. Recent experience suggests that It is difficult to predict where the Chancellor will stop and therefore it may well make sense for someone to consider a transfer to a QROPS now to test their pension against the LTA before it drops further. Just to note any transfer to a QROPS which exceeds the LTA triggers a tax charge of 25% irrespective of how the benefits are later taken i.e. as a lump sum or income.
The recent trend has been quite markedly for the LTA to fall which makes this a reason to consider a transfer to a QROPS.
|Tax Year||Lifetime Allowance|
Income taxed in country of residence
UK pensions are generally paid out net of basic-rate tax. PAYE applies to all pensions from registered pension schemes. However, non-UK tax resident members can apply for payment to be paid out gross by completing the relevant HMRC form. With a QROPS, clients can transfer to a jurisdiction which pays out gross income automatically and charges little or no income tax on their pension benefits so they only pay the tax, if any, applicable in their country of residence.
The new ‘pension freedoms’ rules, subject to the jurisdiction adopting them and the QROPS rules being amended, will enable individuals to access their pensions in their entirety or through phased lump sums if they wish. It is of course important to understand what the tax situation would be and any penalties the QROPS provider may apply, as well as the performance and penalties of the underlying investment before any withdrawal decision is made.
Transferring your final salary scheme could be very good value
Transfer values from final salary schemes have remained at or around historic highs for the last twelve months, and this perceived ‘good value’ has led to significantly more transfer values being taken than in previous years. Some pension scheme members have even reported receiving transfer values of 54 times their annual pension.
This is demonstrated to the Xafinity transfer value index (TVI), which tracks the transfer value that would be provided by a hypothetical DB scheme to a member aged 64 who is entitled to a pension of £10,000 each year, starting at age 65.
However, with interest rate rises in 2018, this window of such good value could set to close and therefore now might be the right time to take advantage.
Final salary schemes are increasingly risky
A defined benefit, better known as a final salary scheme, is the most generous and secure type of pension arrangement you could ever expect to receive. The generosity of these schemes have meant most have been forced to close, restrict access or reduce benefits because they are so expensive for the employer to provide and operate. Those that are fortunate to have been members during their life should in almost all circumstances never consider a transfer away.
This being said there are a number of circumstances which may warrant at least the consideration and review from a highly qualified professional holding the necessary UK Pension Transfer Qualifications.
The main reasons to consider a possible transfer to a QROPS could include:
- The expense to the scheme means the future ability to provide benefits has been jeopardised. If the pension scheme collapses and the employer becomes insolvent the UK Pension Protection Fund (PPF) may honour the benefits so long as the PPF can itself take on the burden. The PPF is not Government backed though but by a levy on other similar pension schemes.
Even if the PPF steps in you must be aware that only 90% of your benefit will be protected with a cap of £32,761 per annum. Therefore people with larger pensions are more likely to be impacted by this.
- You have a large pension and passing on as much wealth to your beneficiaries is a priority for you. The death benefits available are dependent on whether you are a deferred or active member of a final salary scheme.
If you are a deferred member and don’t have a spouse or dependant (child under 23) then your pension income will die with you. Transferring to a QROPS will allow you to pass on a lump sum death benefit to a beneficiary of your choosing.
No Income Tax charge on death – Outside the scope of the 45% tax charge
For UK pensions, so long as an individual is aged below 75 and pensions do not exceed the LTA their pension on death can be passed on to a nominated beneficiary as a tax free lump sum.
However, after the age of 75 pension benefits are subject to a tax charge of up to 45%.
If paid as a dependant’s pension the benefits are also free from tax other than any income tax due from the beneficiary.
With a QROPS regardless of whether the member has started taking benefits (on or after age 55) or not, dependent on how the pension is structured there ‘may’ be no income tax charge imposed on the payment of a lump sum to the member’s dependants on death providing they have been non-resident for at least 5 complete tax years and remain non-resident until the point of death.
The new rules, which apply to death benefits paid out after April 6th 2015 irrespective of the date of death, greatly alter the death benefits on UK pensions.
In summary the rules have altered as follows:
|Benefit type||Payment made on or after 6 April 2015|
|Uncrystallised, member dies before age 75||The beneficiary can: Take a lump sum up to the limit of the deceased’s remaining lifetime allowance, paid tax free, or Take tax free income from flexi-access drawdown, or Buy an annuity with payments paid tax-free.|
|Uncrystallised, member dies on or after age 75||The beneficiary can: Take income from flexi-access drawdown taxed at their marginal rate, or Buy an annuity taxed at their marginal rate, or Take a lump sum taxed at 45%|
|Crystallised (drawdown), member dies before age 75||The beneficiary can: Take income from flexi-access drawdown tax free, or Buy an annuity, which will be paid tax free, or Take a tax-free lump sum.|
|Crystallised (drawdown), member dies on or after age 75||The beneficiary can: Take income from flexi-access drawdown taxed at their marginal rate, or Buy an annuity taxed at their marginal rate, or Take a lump sum taxed at 45%|
Exchange rate risk
Below I have taken the graph of Sterling versus the Euro. For those people based in the Eurozone, holding a UK pension scheme they will have witnessed a roller coaster of a ride over the past 10 years. The graph highlights this fact, which has been caused by the appreciation of the Euro, when it almost achieved parity in late 2008 followed by a lot of volatility and then rebounding to almost 2005 levels in March 2015.
The rule of thumb for any financial advice is to have retirement income paid out in the currency expenditure is expected to be paid in. The majority of an individual’s expenditure will be in the currency of their country of residence. This means receiving an income in Sterling which then has to be converted to the Euro for example, provides a huge risk with currency fluctuations making it very hard to plan from month to month.
Using simple figures of a person receiving a scheme pension of £10,000 and its conversion to Euro’s can illustrate this point when using an example (assuming no inflationary increase in the scheme pension)
June 20th 2005 – £10,000 x 1.50 = €15,000
December 29th 2008 – £10,000 x 1.02 = €10,200
July 24th 2012 – £10,000 x 1.29 = €12,900
March 11th 2013 – £10,000 x 1.15 = €11,500
March 11th 2015 – £10,000 x 1.42 = €14,200
January 11th 2018 – £10,000 x 1.13 = €11,300
Using a QROPS to transfer Sterling denominated pensions then utilising Euro denominated assets to pay out an income in Euro’s could help prevent such large fluctuations in income. This can also protect against a permanent depreciation of a currencies value.
Benefit from Worldwide investment options
A QROPS can access a huge range of investment funds across a multitude of differing currencies using fund platforms or offshore bonds. The will provide to diversify and the opportunity to tailor an investment portfolio to an individual’s specific needs.
UK pensions are understandably structured around UK residents so for an expat who has no intention of returning to the UK they should always consider the benefits that a QROPS may bring.
QROPS are a great way to manage pension assets that have been built up throughout your life. With all the other points in mind, considering the additional benefit of the administrative efficiency a QROPS can bring, it can make a QROPS option compelling, subject to residence.
QROPS have been designed and built in the 21st century for the expat community specifically in mind. This means they are portable and can be used to provide retirement benefits wherever you reside. The correct QROPS can offer similar flexibility to a UK SIPP when it comes to drawing down your income which is great for tax efficiency of income if you match up tax free cash and income.
Bringing all of your historic pensions under one roof makes the ease of administration and investment management much more straight forward. This means it is much easier to monitor and make strategic alterations to your pension fund in order to benefit from opportunities but and respond to any potential market downturn.
If you would prefer to take a more balanced approach splitting your pension assets between a QROPS and a UK based pension always offers the benefit of a hedge between strategies.
Maximising a Spouses Pension
Pension provision for a spouse on the death of a member is often on the forefront of a members mind. With a final salary scheme after a member begins receiving their pension on death it is the norm for a spouse to continue to receive an income but at a reduced level, ordinarily 50%.
With a QROPS it is possible to use up to 100% of the fund to provide a spouses pension. This may be through an annuity or income drawdown arrangement. Many people may wish to consider transferring to a QROPS to ensure the pension asset is able to provide a more substantial retirement income for their spouse.
Continuing advice on your pension assets
A Pension is often an individual’s largest asset which means that if an expatriate leaves it unattended in a UK Pension arrangement the likelihood is it may receive no ongoing adviser oversight. This can be detrimental when you consider the following
- Ongoing alterations to UK Pensions legislation which may impact on your retirement funds; reducing lifetime allowance and the increasing retirement age.
- If you hold a UK SIPP, Personal or Group Pension Plan where is the money invested? This is crucial to whether the pension grows, keeps pace with inflation or at worst falls in value.
- Is the money invested in the correct areas.
Transferring your pensions to a QROPS will bring your assets under an umbrella from where an overseas adviser can help to advise and monitor the pension.
Early Retirement from a Final Salary Scheme
A Final Salary Scheme will often have quite punitive early retirement penalties for those who wish to draw their pension prior to the ‘Normal Retirement Age’ set under the scheme.
For example, a scheme may impose a penalty, known as an actuarial reduction, of 0.5% per month. This means if you retire 12 months early the penalty is a 6% reduction in your annual pension income. In this scenario, if you retire 5 years early the penalty increases to 30% of your annual pension
This may mean that should a scheme member wish to retire early it may be beneficial to review and compare what retirement income could be achieved by transferring the cash equivalent to a QROPS and drawing an income from there.
Protection against creditors in the event of bankruptcy
If you legitimately made pension contributions to an individual pension arrangement and later became bankrupt then the Courts will find it difficult to retrospectively reverse the contribution made to pay creditors.
When benefits finally commence from the pension arrangement you may be ordered to pay these to creditors. In transferring UK pension assets to a QROPS it makes it far more difficult for UK courts to take action.
A home for Divorce Settlements
If a Court puts in place a pension sharing order in respect to pension assets held through a final salary scheme it is down to the scheme trustees to decide whether or not to allow the ex-spouse to become a member of the scheme. If the scheme trustees deny the ex-spouse entry or should they prefer to get a clean break they will have the option to transfer the cash equivalent to a QROPS. This would also be possible with a Personal Pension.
QROPS are outside of the earmarking or pension sharing jurisdiction of the UK courts. In reality if the Courts (and the divorcing client) realise their lack of jurisdictional power they will always have the fall back of reverting to offsetting. This will only be of use to the Courts should the couple’s other assets outweigh that of the overseas pension rights. And of course if the asset is declared.
Transferring UK Pension assets to a QROPS may be seen by some as a step in protecting assets from a spouse on divorce. Quite apart from both the moral and ethical grounds for even considering this, it is potentially fraud. As the law does not forbid a transfer, advisers should ensure that they are not seen to be promoting this or even supporting the activity. This could be seen as a bi-product of the QROPS market which otherwise offers non-residents an excellent method of continuing to save toward retirement in an efficient manner
Final Salary Funding Levels and the Strength of the PPF
The promise to pay a future income is only as strong as the pension scheme and the company who ultimately underpin that promise. There is of course the Pension Protection Fund (PPF) which will step in should the scheme and company fail to meet its obligation to pay the pension income.
There are limits to compensation the PPF will pay and this is dependent upon whether the member had retired at the scheme normal retirement age (NRA), retired prior to the schemes retirement age of not yet retired.
Member has retired
- The Pension Protection Fund will pay 100%
- Payments relating to pensionable service from 5 April 1997 will then rise in line with inflation each year, subject to a maximum of 2.5 per cent a year. Payments relating to service before that date will not increase.
- This information may also apply if you retired through ill-health or if you are receiving a pension in relation to someone who has died.
Member retired early
- If the member had retired early and had not reached the scheme’s normal pension age when the employer went bust, then they will generally receive 90 per cent level of compensation based on what the pension was worth at the time. The annual compensation received would be capped.
- The cap at age 65 is, from 1 April 2014,£36,401.19 (this equates to £32,761.07 when the 90 per cent level is applied) per year. The earlier the date of retirement, the lower the annual cap is set, to compensate for the longer time the payment has been received for.
- Once in payment the payments relating to pensionable service from 5 April 1997 will rise in line with inflation each year, subject to a maximum of 2.5%. Payments relating to service before that date will not increase.
Member has yet to retire
- When the member reaches the scheme’s normal retirement age, we will pay you compensation based on the 90 per cent level subject to a cap, as described above.
- Until normal retirement age is reached and the compensation is put in payment, the compensation entitlement will rise in line with inflation each year, subject to a cap 5% for compensation linked to pensionable service prior to 6 April 2009, and a cap of 2.5% in respect of compensation linked to pensionable service on or after 6 April 2009.
- Once compensation is being paid, then payments relating to pensionable service from 5 April 1997 will rise in line with inflation each year, subject to a maximum of 2.5 per cent. Payments relating to service before that date will not increase.
These limiting factors harshly impact on a member with a large pension income. To put this in to monetary terms a 65 year old male would need a pension fund of circa £1,000,000 to purchase an annuity of £32,761.07 increasing in line with RPI and providing a 50% spouses pension.
This means if the same male had a pension income of £62,760.68 and their pension fund fell into the PPF then they would lose millions because the PPF would only protect up to a maximum of £32,761.07.
This is all assuming that the PPF was able to meet the obligation which when given that the PPF is funded by a levy on pension schemes (which many are in trouble themselves) and the scheme is not guaranteed by the UK Government, its ability to make pension payments could be seriously troubled.
By taking a cash equivalent transfer to a QROPS a member takes control of their own pension funds and removes it from the risk of the pension scheme going bust.
Individual circumstances, income, objectives, experience, underlying costs (including trust, platform type and funds) and attitude to investment risk must be taken into account when considering the above mentioned points.
It is absolutely crucial before making any decisions that you get professional advice from a financial adviser who is suitably skilled, qualified, regulated and experienced.
Transferring your pension must be done with considerable due diligence. Take time to understand the adviser, the products, the charges, the risks, and why you would even consider moving from your existing arrangements to an alternative.
About Mike Coady
Mike Coady is an expat expert based in Dubai and is on hand to help with all of the above and more.
Mike is an award-winning money coach and industry leader in the financial sector.
Qualified to UK Financial Conduct Authority (FCA) standards, a member of the Chartered Insurance Institute, a Fellow of the Institute of Sales Management (FISM), a Fellow of the Institute of Directors (FIoD) and featured as a highly qualified Financial Adviser in Which Financial Adviser.
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Blog published by Mike Coady.