The lure of accessing the whole of one’s pension fund in cash will continue to prove too big an attraction for many to resist. However, the fact remains that for a UK resident “taker of benefits”, aside from 25 per cent of the fund being available as a tax-free pension commencement lump sum, the rest will be fully taxable in the tax year it is taken.
There have been plenty of warnings given as to what this can mean and some will heed these, at least ensuring no more than the basic rate is suffered by staggering the benefits taken over more than one tax year.
One of the main drivers (aside from the obvious temptation of a substantial lump sum) may well be a concern that the “window” through which pension fund benefits can be taken wholly in cash may close in the future.
Undoubtedly, those with the inclination and opportunity to retire abroad may be wondering whether it is possible to relocate to a foreign clime and take all of the benefits from their UK-registered pension scheme in cash completely free of tax. This issue will have had to have been considered even before the new pension freedoms had been introduced.
Many of the potential tax issues surrounding flexi-access are not new. In a sense, the Treasury had a dress rehearsal with the introduction of the more limited flexible drawdown four years ago. The treatment of withdrawals by non-residents, who both stay abroad and subsequently return to the UK, will have had to be considered.
I am grateful to the Technical Connection pension team (and in particular John Housden, a good friend to the business) for carrying out the all-important research into this issue and for the articulation of what the current position appears to be.
The first point to note is that, as the Registered Pension Schemes Manual 0410130 states: “There is no general exemption to income tax for individuals who are living abroad in receipt of a pension from a UK registered pension scheme.”
In practice, other than for government pensions, exemption at source will often be available under a double taxation agreement. In such circumstances a claim will need to be made to HM Revenue & Customs by the pension recipient who will then be subject to tax in their new home country.
Taxation under the new home rules can be very attractive. Indeed, several European Union members have tailored their tax laws to attract pensioners. The most appealing example at present is Portugal, whose “non-habitually resident” tax regime gives an exemption on foreign income sources (including pensions) for the first 10 years of a residency in the country.
When flexible withdrawals appeared in April 2011, the Government put a block on exploitation of such overseas rules by applying a similar set of rules to those for capital gains realised while non-resident. Broadly speaking, return within five tax years would have seen all the income withdrawn chargeable to UK tax in the year of return.
The rule was modified from 6 April 2013, with the introduction of the statutory non-residence test. The five tax years became five years or less.
With the advent of flexi-access withdrawals, there was a further change from 6 April 2015. A charge now only arises when over £100,000 of total withdrawals, excluding any PCLS element, is taken during the non-resident period.
Thus a single uncrystallised funds pension lump sum of £133,000 (£33,250 tax-free and £99,750 taxable) would escape HMRC’s grasp on early return to the UK but a one-off UFPLS of £134,000 would attract tax on £100,500 as the £100,000 threshold is exceeded.
One area of uncertainty is whether, if a UK tax charge arose, this could be offset with or eliminated by tax already paid in the former country of residence. The relevant legislation (section 573CA ITEPA 2003, as amended by paragraph 81 of Schedule 1 Taxation of Pensions Act 2014) states: “Nothing in any double taxation relief arrangements is to be read as preventing the person from being chargeable to income tax in respect of any relevant withdrawal treated by virtue of this section as accruing in the period of return (or as preventing a charge to that tax from arising as a result).”
HMRC’s Employment Income Manual guidance on the old flexible withdrawal rules (see EIM74057) gives no clue.
So there appears to be scope for avoiding UK tax on pensions by emigrating. However, anyone considering this option needs to be aware of the high price of an early ticket back to Blighty.
Tony Wickenden is joint managing director of Technical Connection