When that money is held in an international pension plan the key question is how to start to draw down the income without incurring the wrath of the tax authorities.
Mark Lindsay, associate director at Jersey based trust and fund administration business Elian, says the first step is to make a request to the trustee, who is the legal owner of the savings, asking it to consider distributing their hard earned savings, hopefully with some investment gains mixed in.
Lindsay sets out six steps any trustee will have to take before distributing the funds.
1. Does the trust deed allow the distribution requested?
This may be seen like a fairly innocuous question but if there is no express mechanism for distributing a retiree’s funds the trustee may need to consider an amendment to the trust deed.
This is not such an uncommon scenario given the changing pension rules and guidelines since many IPP’s were first established.
In cases like this, hopefully the amendment power in the trust deed would not hamper any such modification but someone seeking the distribution of their funds may need to take legal advice to ensure no adverse consequences will result for themselves or for the trustee from an amendment to the deed.
Any distribution from the fund would of course result in a cost and that cost would increase if a lawyer was also required to draft an amendment to the trust deed to allow for the trustee to implement the request for a distribution.
Assuming the trust deed enables the trustee to meet the retiree’s wishes, the trustee must consider a number of other steps before any distribution can be made.
2. Do current investments fit the profile?
In a traditional pension savings vehicle the investment profile is changed as the person approaches retirement to cut down on risk.
A risk averse strategy is usually adopted whereby income is invested in government bonds and/or cash as normal retirement age approaches probably in a structured manner over the five years before expected retirement age.
In an IPP, such an investment strategy may not be suitable in the circumstances and any investment strategy to be adopted as a person approaches retirement should be discussed with their trustee and should reflect advice taken on the subject and their own appetite for risk going forward.
A person may want to consider if assets can be easily liquidated as they approach retirement, any tax consequences of switching or distributing assets, and the timing of any asset transitions.
If the trust deed allows, it may be possible to receive pension payments in assets other than cash.
3. Is there a withholding clause/requirement to account for tax?
In most employee benefit trust deeds there will be a clause, which will require the trustee to account for any withholding taxes due on drawing a pension income.
This provision needs to be considered carefully and strictly adhered to. A trustee may look for some form of indemnification from a retiree to ensure that it does not fall foul of the tax authorities following a distribution.
This is not uncommon but the wording of the indemnity should be considered carefully to ensure that it does not provide greater cover than that required by the trustee in the circumstances.
4. Should tax advice be sought?
Tax advice will be required by both the person retiring and their trustee. If their interests are aligned the trustee may, if the retiree has already taken his advice, ask for the same adviser to extend its advice to it.
This is not uncommon and most advisers will oblige.If an adviser is not willing to extend its advice to the trustee, or if there is a disagreement or any uncertainty over the taxes falling due, the trustee will want to seek its own advice from another adviser.
This will of course come at a cost to the fund. The tax advice received should set out the most tax efficient mechanism for receiving the distribution of pension income.
This will usually include a recommendation on the number of years that the income should be paid for and again this will have to be compliant with the mechanism in the trust deed.
The trustee, having received a request for a distribution and tax advice, will need to be careful how it structures the distribution in order to avoid any adverse tax consequences.
This is usually dealt with through the agreement that we will discuss next.
5. Are indemnities or pension payment agreements needed?
As the person retiring would normally be the sole beneficiary of their pension, the trustee will be looking to them to indemnify it and hold it harmless should any issues come to light with regard to the payment of the distribution.
This will particularly be the case in respect of accounting for income tax and national insurance contributions but will probably extend to other matters such as liabilities attaching to the trust assets distributed.
The granting of such an indemnity is normal in these types of scenarios as following the pension payment, the retiree will have full ownership of the trust assets to meet any claims against those assets from third parties, in particular HM Revenue & Customs (HMRC).
It makes sense for the retiree and their trustee to agree how and for how long their pension income will be distributed.
When drafting such a pension contract there are a number of points worth considering:
a) Always refer to the income as ‘pension income’. Not to labour the point but just to be clear that the IPP was always intended to provide pension income.What the tax authorities will view as pension income is open to debate, so it makes sense to remove as many ambiguities as possible to aid the tax authorities when considering how to view a distribution.
b) Retirees should consider asking for their distribution from an age whereby it is common for pension income to be drawn down (usually 50+ unless they are lucky enough to be a professional footballer or other such professional who is expected to draw income at an earlier age).
If a distribution is to be made to a retiree at an earlier age, they may find themselves with a more difficult task to justify that their distribution represents pension income.
In these days of flexible retirement it is becoming less clear what retirement is, and what a retiree is and isn’t required to do to demonstrate that they have entered a period in life where it is appropriate to start drawing on their retirement savings.
The start date and period of pension draw down will differ for everyone, discussing the requirements with a trustee should help a retiree to prepare adequately to meet his needs.
c) If a distribution is to be taken in a series of tranches over a number of years they should be structured in a way that reflects a pension entitlement.
For example rather that taking reducing increments of 25 % per annum consider a lower increment (having taken actuarial advice) over a period of time in excess of ten years.
This is more likely to be viewed as reflecting a pension draw down.Any short period with a high increment may be seen as too aggressive and ultimately the distribution could be viewed as something other than pension income.
Although with the birth of flexible access the job of categorising what form a pension should take has grown increasingly difficult for the tax authorities.
6. Are there any reporting or notification requirements?
The obvious notification requirement will be in respect of income tax (PAYE) and national insurance contributions.
Retirees should always discuss this with their tax adviser. Also as set out above, they should make it clear through their actions, the mechanism for distribution and the pension contract with their trustee that this distribution is in respect of pension income in order to minimise any potential tax difficulties.
Another and more unusual consideration is the new Foreign Account Tax Compliance Act (FATCA), which requires financial institutions such as a trustee to review the accounts that they maintain and report certain account holders to the US tax authorities every year.
The UK has similar legislation in place for reporting financial accounts to the UK tax authorities and the Common Reporting Standards due to be adopted by more than 80 countries will also carry similar reporting requirements.
A trustee is likely to raise this matter and deal with the reporting requirements.
