Do you remember John Major telling us how wealth was to cascade down the generations, and that his aim was to eventually abolish inheritance tax? All these years later UK inheritance tax (IHT) is still with us, albeit that the limits have increased over time to £650,000 for couples and this does take more people out of the IHT net, enabling them to pass more onto their families. Having said this, the change in regulations to allow the IHT nil rate band to be transferred between couples was only introduced as a reaction to increasing house prices, and simply gave a couple the same limit automatically as they could have achieved as a result of correct will planning.
So, what about your UK pension funds, given that for many people this is one of their biggest assets? Changes to the pension legislation over the years, such as the introduction of ‘income drawdown’, have theoretically enabled many pensions to cascade down the generations – but is this actually the case? Everyone thinks that they are free of IHT, and so they are… as long as you haven’t taken any benefits. By that I mean you haven’t taken your tax free cash, and you haven’t taken one penny in income, and you haven’t reached your 75th birthday. Alternatively they are IHT free if you have purchased an annuity, but largely at the cost of not being able to pass the remainder of your fund to spouse or family members on death.
If you are in drawdown the tax charge on death will be 35% with no exempt allowance even between spouses. By “in drawdown” I mean that you’ve started to draw benefits – to be precise this might only mean that, post April 2006, you’ve taken your tax free cash – you need not have taken any income yet to be in drawdown. This 35% charge is not strictly speaking IHT, but another type of death tax charged in place of IHT to the UK trustees of the pension fund, so those who are not domiciled in the UK will still be liable – you don’t escape the charge by leaving the UK and changing your domicile status. You can avoid this payment if your surviving spouse continues with the drawdown arrangement, but in any event this charge will become due on second death, resulting in less inheritance for your family.
If you buy an annuity then that will die with you – any amount you have not used does not get passed on to your heirs – unless you have already bought an annuity for your spouse, which will then cease when he/she dies. So whatever type of annuity you purchase, there will usually be nothing available as an inheritance for your heirs and this portion of your wealth won’t get to cascade down to the next generation.
If by the time you reach your 75th birthday you still don’t want to buy an annuity, you do have the option of what is known as an ‘alternatively secured pension’. This works in a similar way to drawdown, although the maximums and minimums that you can take are more restrictive. However on death the tax charge can be as high as 82.5%, depending on your domicile.
Is there an alternative?
Yes there is! If you are non UK resident, or planning to become non UK resident, you can transfer your pension to a Qualifying Recognised Overseas Pensions Scheme. At the time of your death, if you are not UK resident and have completed five full and consecutive fiscal years of non UK residence, your fund will be entirely free from all of the UK tax charges that are levied on your pension trustees – with the result that you can leave more money to your spouse or family.
All QROPS are approved by the UK government – in order to obtain QROPS status, the provider must meet a number of HM Revenue & Customs rules relating to how and when benefits can be taken. It must also comply with reporting requirements for five complete tax years after the fund holder has left the UK.
QROPS allow the member of a pension scheme to move his or her pension fund outside of the UK with some very attractive benefits.
The advantages of transferring your pension include:
i. Tax free roll-up of your pension plan at all times.
ii. You do not need to buy an insurance company’s annuity so the fund can pass to benefit your heirs.
iii. You may select from a comprehensive range of flexible investment plans, across a wide range of funds, helping you structure your fund for your circumstances.
iv. You can vary your pension income (within limits) to suit your lifestyle and spending requirements.
v. All investment funds are strictly regulated if you use the right provider.
vi. You will enjoy flexible access to your funds.
vii. You can consolidate your different pensions by grouping all your different funds together into one arrangement.
viii. There is no automatic tax reporting in your new country of residence.
ix. You can usually arrange to receive your pension fund benefits in a tax efficient manner in your country of residence.
x. From outset, there is no UK PAYE on the pension regardless of where you may live.
xi. The potential to escape UK taxes on the fund on death even though it can continue to benefit your heirs.
xii. Your investments and income can be in Euros or any other major currency if you wish; you are not restricted to UK Sterling, nor forced to incur unnecessary foreign exchange rate costs and risks.
Most types of pension schemes can be transferred into a QROPS, including protected rights. You cannot, however, transfer a basic state pension or if you have already purchased an annuity or begun to take benefits from a Final Salary Scheme.
Note that not all overseas pension schemes qualify as QROPS so you need to ensure that you only transfer into an authorised scheme.
Transferring pensions into QROPS is a specialist issue and you should only seek advice from suitably qualified and regulated advisers.
Pension transfers are heavily regulated in the UK by the Financial Services Authority (FSA), an independent non-governmental body, given statutory powers that regulate all financial services. Your adviser must be regulated by the FSA and specifically authorised to give advice on transferring UK pensions.