At the time of writing I am choosing my fantasy team for the 2015 Rugby 6 Nations. The rules of the competition leave me with hard choices: I can have a Welsh or Irish fly-half in my team but not both. I want five Welsh players but I can only have three. I do some research on the internet and consult a rugby- playing colleague for guidance.
After much head-scratching, research and consultation, I put my strategy in place.
I imagine many members of UK pension schemes are doing the same, in contemplation of the impending changes on how they can take benefits after 6 April 2015.
The UK Taxation of Pensions Act 2014 paves the way for the implementation of the most radical changes to the UK pensions tax regime since ‘A-day’ (6 April 2006).
After 6 April 2015, members of defined contribution (DC) schemes will have a new set of rules to navigate on how they can take their benefits. The Taxation of Pensions Act introduces new ways in which members of DC schemes can take their retirement benefits, as well as introducing new rules in relation to death benefits and their taxation in the hands of beneficiaries.
Retirement benefits
Currently, a member of a personal DC pension has three basic choices on how they can take retirement benefits:
- Purchase an annuity.
- Designate funds to a capped drawdown fund and draw an income from it within prescribed limits.
- Designate funds to a flexible drawdown fund and draw an income of any amount.
To qualify for this option, the member must have at least £12,000 pa in other secured pension income.
Generally, the member can take a pension commencement lump sum (PCLS) equal to 25% of the crystallised fund, which is free of income tax.
Also, members can choose to leave part or all of their fund uncrystallised. Post-6 April 2015, members will have the following choices:
- Purchase an annuity.
- Designate funds to a flexi-access drawdown fund and draw an income of any amount. This effectively abolishes capped drawdown and removes the minimum income test for flexible drawdown.
- Take an uncrystallised funds pension lump sum (UFPLS). This is quite simply lump sum payment from the pension scheme without the designation of funds to a drawdown fund.
A PCLS can be taken in relation to annuity purchase or flexi-access drawdown. In relation to UFPLS, 25% of the payment is tax-free and the remainder is taxable income.
Example 1 shows the difference between flexi-access drawdown and UFPLS.
Non-UK residents
Income drawn from a UK pension will be treated as UK taxable income in the hands of non-UK resident members. UK income tax will be due, unless there is a double tax treaty between the country of residence and the UK, which contains a provision that results in a gross payment from the
UK pension. Most EU treaties would work in this way. However, other major UK expatriate destinations, such as Hong Kong, Singapore or United Arab Emirates do not, so individuals retiring there will remain subject to UK income tax on UK pension income.
Where a treaty provision does exist, members need to be aware that a gross payment can become subject to UK income tax should the member fall foul of a five-year anti-avoidance provision.
This applies where the individual was UK resident for at least four out of the past seven years prior to departure, and their period of non-UK residence is for five years or less.
However, after 6 April 2015, tax will only be payable if total relevant withdrawals from UK and relevant non-UK schemes during the period of temporary non-UK residence exceed £100,000.
Non-UK resident individuals will have added complexity, therefore, when determining how they take benefits from a UK scheme, or whether they transfer to a QROPS.
Death benefits
Perhaps the most radical of the new rules is the tax position of benefits arising following the death of the member. Under the new rules, post-death benefits can be paid in the form of a lump sum or they can remain in the pension as a flexi-access drawdown fund, available to provide a flexible income to the beneficiaries. Furthermore, the member can nominate any individual to receive a post-death pension, rather than dependents, as is currently the case.
Where the member dies prior to age 75, all benefits, whether they have crystallised or not and whether they are paid as a pension or a lump-sum death benefit, are tax-free for the beneficiaries. Where the member dies on or after age 75 – and, statistically, most will – pension benefits are treated as the beneficiaries’ taxable income and a lump-sum death benefit payment will be subject to tax at 45%.
It is intended the 45% charge will be abolished in 2016, so that lump sums will be treated as taxable income.
The changes to post-death benefits mean a UK DC pension is now a very attractive vehicle – albeit, limited by the lifetime allowance – for tax-efficient wealth transfer, providing a shelter for future generations from inheritance tax (IHT). It is hard to believe just a few years ago the maximum tax payable on lump sum death benefits was as high as 82%.
For non-UK residents, a QROPS can also act as an effective wealth transfer vehicle, both from an IHT – assuming the QNUPS regulations are amended in respect of non-EU schemes – and income tax perspective, so the merits of whether to transfer overseas or not still need to be considered.
In both cases, for UK-domiciled individuals there is real merit in retaining funds in a pension wrapper for as long as possible, with a retirement decumulation strategy concentrating on utilising non-pension assets first. So much for the Lamborghini.
And, like my fantasy rugby team, the choices – when and how to decumulate, to transfer overseas or not – should only be made following expert guidance
