For most people, a crucial source of income in their retirement is their pension, but if they choose to retire abroad what is the tax position?, says Jason Porter, director of specialist expat financial planning firm Blevins Franks.
To a large degree, a comfortable retirement is likely to depend upon the size of the pension fund, which could be spread across several different schemes.
Those who have had a varied working life could have both private and company (occupational) schemes, a defined benefit arrangement with a local authority or government body, and an entitlement to the state retirement pension.
Understanding the tax treatment of each scheme in the UK is important. And this becomes more complicated if clients are considering retiring to Europe, where each state has its own pension legislation, which each UK scheme will be shoe-horned into and taxed.
Without cross-border government agreement, there would be a very high probability of pension income being taxed in both the state where the scheme is registered (likely to be the UK), and the country where they are living. Double Tax Treaties (DTTs) eliminate many situations where this could occur.
DTTs follow an OECD template, with different sections for each source of income and gains. The pensions articles state that in the main the taxing rights on private, company and state retirement pensions lie with the state where the taxpayer lives, while UK government pension is only liable in the UK.
Pension income will be taxed in the same way as earnings, self-employment and domestic pensions, where local allowances and reliefs can reduce the taxable amount. The net sum will then be taxed through the local scale tax rates. Most EU states do not charge social payments on pension receipts, but exceptions do arise (potentially France).
New UK pension legislation in 2015 introduced much more freedom in how clients can access the pension funds held in defined contribution occupational or private pensions once they reach the age of 55. This includes:
1. Leave the pension pot untouched. On this basis, it will remain invested.
2. Seek a secure or guaranteed income for life, otherwise known as an annuity.
3. Opt for adjustable income, or ‘flexi-access drawdown'.
4. Take money in annual or irregular amounts, called ‘Uncrystallised Funds Pension Lump Sums'.
5. Cash in the whole pension pot.
6. A mixture of some of the above.
While UK resident, points 3, 4, 5, and 6. can include the 25% tax-free cash sum. Any annuity, or withdrawals exceeding this amount are taxable in the year they are received. Clients can still take a lump sum withdrawal once they have left the UK, but the tax treatment will depend upon the local pension tax rules.
This is important, as there is unlikely to be a tax-free element of the pension in the country they might move to. If it is their intention to take this amount, they should try to do this while they are resident in the UK to maximise the tax benefit.
Several of the nations favoured by retiring Britons have some interesting pension tax breaks which can be used once they arrive. But on the downside, there are also negative tax consequences to be aware of - all depending on where they choose to move to.
Portugal has a special tax regime for arrivals who have not been resident in Portugal in the previous five years. If they register as a ‘non-habitual resident', then will only pay 10% Portuguese income tax on any pension income for the first ten years they are resident. But they must apply for this by 31 March of the year following when they became tax resident.
This could obviously be used against annuity income or pension drawdown, but many Britons who have moved to Portugal have taken the option of encashing their whole pension fund and only suffer 10% tax (this might have been up to 45% in the UK).
France, often construed as a high-taxing jurisdiction, is actually quite attractive for retirees. Here, UK nationals of state pension age would suffer similar scale rates of tax as they would in the UK on general pension income, but they have a further three choices of how to tax a single lump sum withdrawal, one of which is a flat 7.5% tax rate (if they were under state pension age, they would also suffer 9.1% social charges). As there is also a 10% allowance, the rate is really 6.75%.
In Cyprus, Britons have two options, where foreign pension income can be taxed at the normal Cypriot scale tax rates, or benefit from a €3,420 allowance and the excess taxable at only 5%.
While in Spain, Brexit could result in a change in the way UK pensions are treated for Spanish wealth tax. UK pension plans have generally been exempt from Spanish wealth tax. But now as a ‘third country' (i.e. outside the EU/EEA), they may no longer qualify for this exclusion.
While the current wealth tax exemption does not differentiate between Spanish, EU and non-EU pension plans, and as a consequence all should be treated the same, a recent binding ruling from the Directorate-General for Tax (DGT) in Spain states that ‘pension plans established in non-EU member states may not benefit from the [wealth tax] exemption'.
An option, and something which might help in this instance is transferring a UK pension scheme to a QROP (Qualifying Recognised Overseas Pension) based in the EU, though this would need to occur before they become a Spanish tax resident.
As a result of new responsibilities placed upon pension scheme trustees, a transfer of this nature is often a drawn-out exercise, so they would need to plan for this well in advance of arriving in Spain.
By Jason Porter, director of specialist expat financial planning firm Blevins Franks.
