International annuities targeted at retail investors are emerging in the offshore market which allow QROPS or QNUPS when crystallized to provide highly tax-efficient income for UK tax residents.
They offer similar flexibility as traditional drawdown together with the same attractive tax advantages of a ‘purchased life’ annuity.
A typical example of this is the Guernsey regulated lifetime flexible annuity offered by Cavendish PCC.
How regulated lifetime flexible annuities work:
When a client with offshore pension savings (e.g. QROPS / QNUPS) wishes to access some of their money, they can transfer their pension to a registered offshore annuity provider.
Once the pension is transferred, the annuity provider invests the money in much the same way as it was previously, e.g. within an offshore bond, with the same investment manager/adviser taking responsibility for managing the investment.
From time to time, a calculation is undertaken to determine the maximum level of income which can be taken from the flexible annuity, helping to ensure the investment funds continue to meet the income needs of the client without depleting the capital.
As with standard drawdown, income cannot be guaranteed for life, and it does depend on investment performance and the income level taken.
If the annuitant dies, the remaining investments are not lost and can be passed on to the annuitant’s beneficiaries, either by way of an annuity or as a lump sum. Importantly, the remaining funds are not subject to inheritance tax (IHT).
Tax advantages of lifetime flexible annuities:
A lifetime flexible annuity is designed to provide the same tax advantages as a UK purchased life annuity.
So, any money paid from the flexible annuity has two components, one component is deemed a return of capital and isn’t taxed, the other component is deemed an interest component and is taxable.
With current interest rates at an all-time low, the taxable component of the annuity is correspondingly small.
In contrast, the income received through drawdown (above the pension commencement lump sum amount) is taxed at a client’s marginal rate of tax.
However, it’s not a simple case of building up pension savings and transferring it all over to an offshore annuity provider to benefit from this tax advantage.
Benefits are limited to offshore savings which have not benefited from tax relief on contributions.
For QROPS, this means any money which was transferred across into the QROPS from a registered UK pension scheme is not advantaged by purchasing a lifetime annuity.
However, any growth on the funds transferred into the QROPS is eligible for investment into a lifetime annuity and can benefit from these tax advantages.
For QNUPS, the entire pension can be transferred into a flexible annuity as none of the pension fund has benefited from tax relief on contributions.
This can create an extremely beneficial situation for clients and can significantly help reduce the amount of income tax payable, e.g. for a male, aged 65, the effective rate of tax (for a higher rate tax payer) could be just 6% through a flexible annuity.
Furthermore, upon the annuitant’s death, the remaining plan value is available to nominated beneficiaries without being subject to IHT.
Advisers need to be aware of the decumulation opportunities:
Up until now, regulated flexible lifetime annuities have been fairly niche.
The market is now developing and looks set to create new opportunities for offshore investors, especially British expats returning to the UK.
They will also be of interest to those in Civil Law jurisdictions, such as Spain and France, where the efficiency of annuities can make them more attractive over conventional offshore savings.
The development of lifetime flexible annuities is still relatively new, with very few providers offering them.
It is important for advisers interested in moving their clients from a QROPS or QNUPS into a lifetime flexible annuity to carry out their own careful due diligence in this area.
The demand for tax-efficient income and inheritance tax efficiency when it comes to the decumulation stage of financial planning is growing.
Developments in this area are welcome and they can really make a big difference in some situations.
They could even make transfers into QROPS more attractive to do sooner rather than later as it’s the growth within the QROPS which will be eligible for the flexible annuity, so the sooner the money is transferred, the more growth there could be as a proportion of the total value at retirement.
