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Strong Headwinds for British Expats Looking To Transfer Their UK Pension Benefits Into A QROPS? Image

Strong Headwinds for British Expats Looking To Transfer Their UK Pension Benefits Into A QROPS?

August 02, 2022

Many British expats who decide on retirement in Spain or retirement in Portugal will transfer their pension benefits into a QROPS (qualifying recognised overseas pension scheme). The main advantages are that a QROPS allows your pension assets to grow beyond your UK lifetime allowance, they provide more generous death benefits and offer the potential to benefit from lower tax on income payments in your new country of residence. Where possible, it is always advisable, to transfer your UK pensions, before it exceeds your UK lifetime allowance limit and incurs a tax liability on any excess. Once it’s in a QROPS, it is no longer subject to these constraints and can continue growing well in excess of the UK lifetime allowance. Recent legal and political developments, however, could have ramifications for those who opt for the QROPS route. Here’s what to expect.


Possible changes to the Overseas Transfer Charge.


In 2017, HMRC introduced a rule that applied a 25% tax – known as the Overseas Transfer Charge – on certain transfers made from a UK pension to a QROPS on or after 9 March 2017.

This financial penalty – applicable to the entire value of the pension transfer – is not required if certain conditions are met. These include if the member is resident in the same country as the QROPS they are transferring their pension to, (which is a difficult condition to satisfy as QROPS trustees are often based in offshore financial centres) or if they are living in a country within the European Economic Area.

You may however be subject to an OTC if within five years of the transfer, you move outside the EEA or you transfer your pension fund out of the EEA.

The status quo was muddied considerably with the advent of Brexit, with uncertainty as to whether these rules would be extended to UK pensions transfers to the EU. The question everyone is asking is whether thousands of British expats retirees retiring to Spain and Portugal post-Brexit will be hit with a hefty tax bill?

HMRC eventually offered clarification, stipulating that if you transfer your pension to a QROPS in the EEA and you are a resident in the EEA, or Gibraltar, you will not be liable to a 25% tax charge. The caveat remains that if you or your pension moves outside of the EEA or Gibraltar within 5 years then you may be subject to the 25% OTC.

However, the post-Brexit political world continues to be an uncertain one, and recent tensions between the UK and EU regarding the Northern Ireland protocol may throw into flux existing arrangements. This is heightened by the fact that, having left the EU, the UK is no longer legally bound to follow the former’s rules on the freedom of capital movement. It’s possible that the UK may in the future change its stance and impose wider-ranging penalties on pension transfers to the EEA. The window may indeed be closing and its important to consider your options now before it’s too late.


New UK Pension Transfer Regulations introduced in November 2021


Another key development in pension transfers is the introduction of new rules in November 2021 that empower UK pension ceding schemes to determine – via the use of a traffic light system – whether a UK pension can be transferred into a QROPS.

The Pensions Schemes Act 2021 endows trustees with the ability to refuse transfers when there is an increased risk of pension scam activity, and request additional information from members to ensure a transfer is risk-free. This is done using a system of red and amber flags. Red flags apply to certain scenarios that are viewed as high risk and the transfer cannot proceed. An amber flag is used when there is an increased risk of pension scam activity, and the transfer can only proceed if evidence is provided that the member has taken scam guidance from the Money and Pensions Service.

UK pension transfers into a QROPS are subject to more conditions. Evidence must be supplied by the member that establishes a ‘residency link’ – that the member is resident in the same country or region where the QROPS is established. This would apply in the same manner if both the individual is resident and QROPS established in the EEA or Gibraltar. If insufficient evidence is provided to demonstrate this residency link then an amber flag will apply and the appropriate steps will need to be taken.

Increased checks to protect against pension scam activity is a laudable aim, although it’s possible that these new rules are also motivated by a desire to protect the UK pension industry from pension capital outflows.

One consequence of the new regulations is that since their introduction the rate of pension transfer flag warnings have soared – in April 2022, 78% of transfers reviewed raised at least one warning of a potential scam according to XPS Pension Group’s Scam Flag Index tracker – the fourth consecutive rise in as many months. This has coincided with a fall in the rate of completed transfers in the XPS Transfer Activity Index.


Tax treatment of QROPS pension income in Spain and Portugal 


Pensions in Spain


Many British expats choose to retire in Spain or obtain residency in Portugal, and their pension income will be key to establishing a new life in these countries. When it comes to managing pension assets, it’s essential to understand how these nation’s tax laws distinguish between different pension schemes. This principally applies to the differing treatments of employee-sponsored schemes in the UK funded by employer contributions (where the member has not been taxed on those contributions), and a retirement savings scheme (which may or may not be a SIPP Pension) funded by the employee from taxed earnings which is transferred to a QROPS.

Why is this important? If you are planning on retiring abroad, you need to understand the tax treatment of pension income, and how employer sponsored schemes are less favourably treated than retirement savings schemes.

It’s possible to significantly reduce your tax burden on pension income if your QROPS has been funded by personal retirement savings from a UK pension. You are then able to apply for an annuity certificate in order for   pension income to be treated as a temporary annuity (this is not an annuity in a UK context where you forfeit your pension to secure a fixed rate of return. All you need to do is fix your income for a period of time but your pension remains fully invested and critically, any residual value in the scheme on your death can be passed to heirs.) This means only a proportion of your income will be subject to Spanish tax, with an effective tax rate of between 3.5%-11.5% per annum – depending on your level of drawdown.


Pension Portugal


Those retiring in Portugal who successfully apply for Non-Habitual Resident (NHR) status will see their pension income taxed at a rate of 10% (for a 10-year period). Those who establish a QROPS pension which has been funded from a UK retirement savings as opposed to an employer sponsored scheme, could if structured correctly, result in an effective tax rate of just 1.5%.

Due to the complexities of some pension schemes, when it comes to employer and employee contributions, pension consolidations and the time which elapses after a pension is transferred overseas, it is sometimes not possible to trace back the origins of pension funding, as a result of which, it is not always clear whether an individual is legitimately entitled to avail themselves of the temporary annuities to mitigate tax.


Transfers from a UK defined benefit scheme (DBS) to a QROPS


In recent years, the Financial Conduct Authority (FCA) has tightened the parameters for those wishing to transfer out of their Defined Benefit pension schemes, including those wishing to transfer to a QROPS. These restrictions are increasing over time and it would not be surprising to see the FCA block transfers from DB schemes in future regardless of the individual circumstances.

On the plus side, while it is still available as an option, a transfer to a QROPS pension offers sizeable benefits. These include increased income flexibility and a reduced tax burden; more choice over who receives your pension income after your death; avoidance of the life time allowance (LTA) on growth following a transfer; and better currency options.

The Financial Conduct Authority (FCA) is tightening the parameters for defined benefit transfers and quite rightly so. As this is an irreversible process, one needs to be aware of the possible drawbacks. This includes no guarantee of growth; lack of protection from market volatility and inflation; and the loss of a guaranteed annual income for life – a considerable advantage given the increasing advances in medicine and life expectancy.

Whatever decision you make, it’s important to consult a qualified and expert financial advisor who will factor in your best interests and needs, as well as the current legal and political environment, when advising you. Whether you are moving to Spain or moving to Portugal from UK, it’s important you speak to a cross border UK pensions transfer specialist who understands the rules.


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