Double Taxation on UK Pensions
In the Autumn Budget announced on 30 October 2024, Chancellor Rachel Reeves introduced significant changes to the inheritance tax (IHT) treatment of pensions. Starting from 6 April 2027, most unused pension funds and death benefits will be included in an individual’s estate for IHT purposes. For UK expats, this marks a major shift in how pensions are taxed and could have a substantial impact on the financial legacy left for your loved ones.
Additionally, recent developments regarding Qualifying Recognised Overseas Pension Schemes (QROPS) have introduced further tax complexities for expats considering pension transfers. This article explores the implications of these changes and strategies for mitigating the effects.
Current Rules (Before April 2027)
Under the current system:
Death Before Age 75: If you pass away before age 75, your beneficiaries can inherit your pension pot completely tax-free. This has been a significant benefit for those planning to pass on wealth efficiently.
Death After Age 75: If you pass away after age 75, your beneficiaries pay income tax on withdrawals from the inherited pension at their marginal income tax rate. Crucially, the pension remains outside your estate for IHT purposes, meaning it is not subject to the 40% inheritance tax.
This arrangement allows pensions to serve as a tax-efficient tool for transferring wealth.
Changes Effective from 6 April 2027
The changes announced in the Autumn Budget will dramatically alter this landscape:
Inclusion in Estate for IHT: From 6 April 2027, unused pension funds and death benefits will be included in the value of an individual’s estate for IHT calculations. This means pensions will no longer be exempt from the 40% inheritance tax if the estate exceeds the nil-rate band.
Potential Double Taxation: Beneficiaries will still be required to pay income tax at their marginal rate when withdrawing funds from the inherited pension. This creates a potential double taxation scenario:
QROPS and the 25% Overseas Transfer Charge
For expats considering transferring their pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS), recent developments have introduced significant challenges:
Overseas Transfer Charge (OTC): A 25% tax charge applies to QROPS transfers unless specific conditions are met, such as:You are a tax resident in the same country where the QROPS is based.The QROPS is an occupational pension scheme, and you are an employee of the sponsoring organisation.
If these conditions are not satisfied, the 25% OTC is levied on the transfer value.
Removal of EEA Exclusion: Previously, transfers to QROPS within the European Economic Area (EEA) were exempt from the OTC if the individual was resident in an EEA country. This exclusion has now been removed, increasing the likelihood of the 25% charge applying.
These developments make QROPS transfers far less attractive for many UK expats, especially those residing in countries where residency conditions cannot be met.
Implications for UK Expats
For UK expats, the combination of the changes to inheritance tax rules and the complexities of QROPS transfers could create significant financial challenges:
Reduced Wealth Transfer: The combined impact of IHT, marginal income tax, and the 25% OTC could leave beneficiaries with significantly less than expected.
Jurisdictional Complexity: Navigating tax obligations across borders adds further complexity, particularly for those living in countries without double taxation agreements with the UK.
Reassessment of Pension Strategies: The inclusion of pensions in IHT and the limitations on QROPS transfers mean UK expats need to rethink how pensions fit into their overall wealth and estate planning.
Steps to Mitigate the Impact
While these changes present challenges, there are strategies UK expats can adopt to minimise the tax burden:
Review Pension Structures: Given the 25% OTC, QROPS is unlikely to be a viable option for most. Instead, consider alternative structures or tax-efficient investments depending on your country of residence.
Optimise Estate Planning: Tools like trusts or gifting may help reduce the value of your estate and mitigate IHT. Working with a financial adviser experienced in expat tax planning is crucial.
Leverage Tax Treaties: Many countries have tax treaties with the UK that can help reduce the impact of double taxation on pensions.
Diversify Wealth: Avoid over-reliance on UK pensions by diversifying your investments into assets not subject to both IHT and income tax.
Strategic Beneficiary Planning: Discuss the implications with your beneficiaries and plan withdrawals strategically to minimise tax liabilities.
Why You Should Act Now
The April 2027 changes to pension taxation and the increasing complexity of QROPS transfers underscore the importance of proactive financial planning. Starting now gives you time to explore your options and develop strategies to protect your wealth and ensure it is passed on efficiently.
Get in Touch
If you’re concerned about how these changes could impact your financial future, let’s discuss your options. As an international financial adviser, I specialise in helping UK expats navigate complex tax and pension regulations. Together, we can build a tailored plan to safeguard your wealth and minimise tax liabilities.
Message me today to arrange a consultation and take the first step towards securing your financial legacy.
Written by Dion Angove, Financial Planner for Expats!
Personal Bio - https://about.me/angove
Email - dion.angove@skyboundwealth.com
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