The issues are:
• If you die at or after age 75 what are the tax implications on your pension fund money?
• Would transferring the pension fund offshore before age 75 save you any taxes that would otherwise have been payable?
Tax implications on a pension fund if you die after age 75
Assume the following:
• You have not taken an annuity or gone into ‘drawdown’, i.e. your pension fund benefits have not yet crystallised.
• You may or may not have dependants who will benefit from your pension fund.
• You are UK resident and a UK taxpayer.
From 6 April 2011 there is no compulsory requirement to annuitise your funds at any time, nor to take the tax free cash lump sum at any time. Assets passing to spouses and civil partners, children and financial dependants and charities will not suffer inheritance tax (IHT). Pension assets passing to your estate if you have no dependants or nominated beneficiaries may be subject to IHT at 40%. However, there may be other taxes payable, as below.
If you die after age 75, before taking any benefits, the pension fund can pay out to spouse, civil partner or nominated beneficiaries, but there is a tax charge of 55%. There is no tax charge on a lump sum payable to charity.
Strategies to reduce the incidence of tax
1. Plan ahead - This depends on your pension funds available and other retirement income. Take the maximum tax free lump sum which can then be IHT protected, or gifted to others. If you die at any age, but have taken benefits then any lump sum payable is still taxed at 55%, whilst pensions payable to dependants from your funds are taxed at their marginal rates of tax.
2. Draw down - If you don’t need the fund for pension benefits, draw down as much as you can to deplete the fund. Tax protect the income, or give it away. If you qualify for flexible drawdown (meeting the minimum income requirement (MIR) of at least £20,000), withdrawals are unlimited but taxed at your marginal rates.
3. Mitigate - Partially offset the tax payable later by investing amounts drawn down or taken as a tax free cash into qualifying EIS investments which give you tax relief at 30% or 50% (under the seed EIS).
Transferring the pension fund offshore
There are two options to consider. Whilst an individual is resident in the UK or has been for any of the past 5 complete tax years, the QROPS (Qualifying Recognised Overseas Pension Scheme) or QNUPS (Qualifying Non UK Pension Scheme) rules require benefits to be paid in line with those that could be paid if funds were still held in the UK pension scheme. Once you cease to be a UK tax resident for 5 full tax years, then it is the rules in the place of registration that apply. One of the main advantages of a QROPS is that the balance of funds on death can be left to named beneficiaries without a tax charge.
If you are UK resident then the same UK type rules will apply to you, if you transfer your pension funds offshore, unless you become non resident for 5 tax years. Therefore the QROPS pension transfer route will not offer the reader any of the advantages he seeks.
If intending to retire abroad, then possibly the QROPS pension funds transfer will provide you with greater flexibility and less tax payable than your scheme would remaining in the UK.
The QNUPS is available to both UK residents and non residents. A QNUPS is a Qualifying Non UK Pension Scheme. It was introduced as part of the IHT rules (The Inheritance Tax (Qualifying Non UK Pension Schemes) Regulations, SI 2010/051). There are no reporting requirements for a QNUPS to HMRC. There is also no requirement to be in a jurisdiction where DTA (double taxation relief) applies, as with a QROPS.
The QNUPS will exempt a pension fund from IHT on the death of a pension member if no lump sum or other payment was drawn down from the retirement fund.
There are very specific benefits to QNUPS. The primary benefit is that your assets are effectively removed from the UK tax net and introduced to a new tax environment depending on your residence. This can lead to a substantial increase in income derived from your retirement fund. QNUPS also allow individuals to invest more regularly into their pension pot than the UK annual allowance of £50,000.
There can be problems if the only reason for setting up a QNUPS is to avoid IHT in the UK. There is a danger that, where the member is in ill health and sets up the QNUPS with the sole objective of avoiding IHT, HMRC could seek to attack the arrangement. They would do this by trying to claim the pension was essentially a sham and was no different to a normal trust. This could lead to the member suffering a lifetime IHT charge on the transfer into the QNUPS, and a further charge on his death if he were to die within seven years. However, the biggest potential advantage of a QNUPS is that they are exempt from UK IHT on the member’s death. The Government has recently abolished IHT for approved UK pension schemes. However, they have replaced this 40% tax with a new special tax charge of 55%, imposed before the benefits are paid out to the beneficiary.
The charge applies irrespective of where the member was resident before death, and where the beneficiary receiving the benefit is resident. But a QNUPS fund is exempt from the new 55% charge.
Practically, the reader would have to transfer his funds to a QROPS first and then to a QNUPS, and the QROPS rules would apply in the first instance (to be of effect, you would have to become non-resident for 5 full tax years). If the reader was taking out a new pension plan (and not a transfer) then he could go directly into a QNUPS and contribute to that and would have immediate potential IHT advantages. There is no tax relief on contributions, and these are unlimited.
Practical Tip :
Discuss your options with a qualified pensions and tax adviser - you could save tax, but more importantly remember that pensions require investment advice, which is outside the scope of this article. Ensure you have nominated beneficiaries to your pension funds on death and that your will is up to date. QNUPS and QROPS are specialist advice areas, so take care before proceeding.
Tony Granger
