It is now mandatory for a UK-based adviser with appropriate pension permissions to advise on and transact any transfer from a UK pension scheme that is defined benefit or which has safeguarded benefits, where the transfer value exceeds £30,000 ($45,700, €42,800).
This follows the introduction of the UK pension reforms in April 2015, via the Pensions Schemes Act 2015. When this analysis is undertaken in the UK, a main determinant of whether or not a final salary pension transfer will be in the client’s best interests is a critical yield analysis.
The aim is to work out the annual rate of return required for a transfer to an alternative UK pension scheme to make the defined-pension transfer at least as beneficial for the client over time. The outcome is considered with the client’s risk profile and overall personal circumstances to determine the most appropriate advice.
But what if the client is resident abroad and not planning on returning to the UK? How relevant is the standard critical yield analysis? What other factors need to be considered?
Double tax agreements
When considering the financial effect of a pension transfer abroad, there are many more things to consider for non-UK tax residents than there are for UK nationals. These include the effect of double tax agreements (DTAs), growth rate assumptions set by overseas regulators (pre-post tax), nil-rate tax band levels, tax exemptions associated with different visa classes, and international morbidity and mortality rates.
The effect of DTAs between the UK and other countries is fundamental. DTAs outline how UK pensions are taxed for those who have moved overseas. In many cases, the DTA indicates that tax payable is determined by the jurisdiction in which the client is tax resident and no longer taxed in the UK. In other cases, the onus falls back onto the UK to tax the benefits.
This difference can significantly affect whether a pension transfer is in the client’s best financial interests. In many cases, this factor can be more important on arriving at a transfer decision than relying on the outcome of the UK’s critical yield analysis, which is based on a UK-UK transfer.
Put simply, a critical yield (net of tax) needs to be calculated allowing for the effect of the DTA. Consider an example case in which a DTA exists with the UK and the pension is taxed in the country of residence (see Example 1 on page 2).
Key assumptions
In this case study (Example 1), there are three further particular assumptions. First, that John’s country of residence taxes worldwide income, including receipt of his UK pension payments, at his local marginal tax rate. Second, for any pension transfer into John’s country of residence, no tax is payable on transfer of funds, growth of the fund after retirement or pension drawings. Third, there are no limits on contribution levels and no UK lifetime allowance taxation issues applicable.
Although John’s critical yield (after fees) is likely to be higher in some cases than that considered reasonable for a UK-UK pension transfer, especially after allowing for adviser and fund-based remuneration, could it still make sense for John to transfer his pension to a recognised overseas pension schemes (ROPS) abroad (all other factors being equal)?
