The UK Government (with cross-party support) is introducing sweeping pensions reform, the most radical in decades. Interim changes took effect on 27 March, and more radical changes will follow in April 2015 following public consultation.
Even though there was no tinkering with the QROPS rules, advisers will need to know about the changed UK pension landscape and where QROPS sit in it as far as expatriate clients are concerned.
Immediate changes
With effect from 27 March 2014:
- Capped drawdown has increased from 120% to 150% of GAD.
- The minimum income requirement (MIR) for flexible drawdown has reduced from £20,000 to £12,000 pa.
- The £18,000 trivial commutation limit (from age 60) increased to £30,000.
- The £2,000 limit on ‘small lump sums’ increased to £10,000, and three (previously two) such schemes can now be commuted from age 60.
Future changes
Enormous changes (bringing in enormous tax) will be introduced from April 2015:
- The limits and restrictions applicable to income drawdown (both ‘capped drawdown’ and ‘flexible drawdown’) are completely removed, meaning that full commutation is an option, regardless of a person’s income/MIR.
- Withdrawals in excess of the normal 25% tax-free lump sum will be taxed at the member’s marginal rate of tax (as opposed to being subject to the combination of the unauthorised payment charge, unauthorised payment surcharge and scheme sanction charge).
- The ‘normal minimum pension age’ (NMPA), currently age 55, is proposed to increase to 57, at the same time as the State Pension Age increases to 62 in 2028. (However the Government is consulting on other options, such as the NMPA rising to 62 in 2028).
- Transfers out of public sector final salary schemes will be prohibited, except in ‘exceptional circumstances’.
- Transfers out of private sector final salary schemes may also be stopped, although this is being put out to consultation.
- Government will consult on the tax % applicable on death post-retirement, with the expectation that the current charge of 55% may be reduced.
- QNUPS – HMRC has declared its intent to consult on ways to ensure fairness and remove opportunities to avoid inheritance tax. Legislation will be introduced in Finance Bill 2015. This is effectively a knock-out blow for QNUPS. Consultation will take place over a 12-week period, finishing in mid-June.
Adviser considerations
The UK Government has fundamentally changed its stance on the principle that tax-relieved pension funds should be used to provide an income during retirement. Pensions liberation is a crime at age 54.9, and rightly so. It is just as much a crime, in terms of tax-planning, at age 55. Unlimited flexible drawdown may have a place for smaller pension pots. But it is absolute madness for a typical QROPSsized pension pot.
There are a number of important issues that QROPS advisers need to immediately consider in light of the proposed UK changes.
1) QROPS may evolve to reflect the direction of travel in the UK tax rules. Jurisdictions such as Isle of Man and Gibraltar already allow pension based on actuarial drawdown, which at present is equivalent to around 156% of GAD.
2) The tax on distribution of lump sum death benefits post-retirement is unchanged for now. A UK scheme has to charge tax at 55%, regardless of where the member was tax-resident, whereas a Gibraltar scheme is not subject to any tax charge, with the full fund being distributable on death. Although the UK could reduce its 55% charge following consultation, I believe it is unlikely to reduce below the current IHT rate of 40%.
3) A member who cashes out a large pension pot will increase their taxable estate. The IHT allowance of £325k is frozen until at least 2018, so removal of wealth from the shelter of an IHT-exempt pension pot will result in more estates being caught within an ever tighter IHT net.
4) The window of opportunity to transfer out of final salary pension schemes is closing. For clients with deferred benefits in these schemes advisers should consider the merits (or otherwise) of transfer of these funds without delay.
5) The UK last made significant pensions reform in April 2006 (‘A-day’), and after only eight years they are doing so again. This volatility does not allow advisers and clients to plan for retirement with any confidence or certainty. A transfer to a QROPS in contrast will crystallise a client’s UK pension benefits and firmly place their retirement fund in a jurisdiction which offers legislative stability.
6) The lifetime allowance (LTA) tax charge, which has raised over £230m to date, has reduced to £1.25m. The LTA is expected to remain on a downward trend, with some commentators suggesting it will fall to £400-500k in real terms. Transferring to a QROPS ‘crystallises’ the LTA test, giving protection thereafter. It takes the everdecreasing LTA out of the picture, and is a really valuable LTA escape route. Use it while you still can.
Tax traps
What about taxation of income taken from a UK scheme by non-UK residents? Although pension liberation after age 55 might seem very alluring, there are some horrendous tax traps which must be fully considered by the adviser and the client. To quote one leading UK financial adviser:
“It’s just flexible drawdown with no minimum income requirement. Suitability rules aren’t changing, so it will be recommended to very few. Unless the FCA scrap conduct of business rules and our PI insurers no longer care, flexible drawdown won’t become a mainstream option”.
The largest single issue in relation to a non-UK resident cashing-out a UK pension scheme is tax. UK residents will be taxed at their marginal rate on any income taken. HM Treasury estimate that around 30% of UK DC members will take advantage of the new ability to draw down at a faster rate, and the expected tax implications of this will be an extra £1.2bn pa in income tax receipts by 2018/19. So the new flexibility comes at a considerable cost for those who are enticed by it.
The average QROPS member with a fund of £300k would be looking at a tax charge of 45% – which is not much different to the 55% tax charge that would currently apply via the member payment charge regime.
