In scenario one, John draws his pension from the UK scheme as income and is taxed at his marginal tax rate abroad, assuming a 45% marginal rate on income. In scenario two, John transfers his UK pension entitlement to a locally based ROPS and draws his pension from the ROPS at the same level that he would have received from the UK scheme after tax.
Putting the two scenarios together, even though the UK critical yield is regarded as being relatively high, after also allowing for fees, the tax differential has resulted in a significant extra fund value available for John to pass onto his beneficiaries on death. There is no real comparative after-tax loss of income compared with receiving the pension from John’s UK scheme over time. This extra benefit could also have been re-allocated over time to help John further supplement his income during his retirement.
There are other things that will have a significant bearing on whether a defined-benefit pension transfer to a ROPS is in the client’s best interests. Namely, the effect of growth rates, inflation rates, taxation within the fund, country risks, exchange rates and mortality rates. These considerations will also help to establish whether the comparative UK critical yield is an appropriate measure for decision-making, and if not, what critical yield level should be deemed appropriate?
As one example, pension regulators in different countries set different growth rate assumptions for the purposes of forecasting pension benefits. The Financial Conduct Authority has a standard growth rate assumption of 2%/5%/8% for projecting pension benefits on a gross basis for low-growth/medium-growth/high-growth portfolios. Many UK pension providers tend to also project based on real rates of return at -0.6%/2.4%/5.4% per annum.
If the jurisdiction abroad has a different set of assumptions for growth and inflation pre/post retirement age – which tends to invariably be the case – things will be different (see Example 2). The 1% per annum difference between these two scenarios makes a big change to the value of John’s fund at retirement age, and would lower the comparative critical yield required from an overseas scheme compared with considering a UK-to-UK transfer in isolation.
Lifetime allowance
The effect of the reduced lifetime allowance in the UK, lowering from £1.25m to £1m from April 2016, is another key factor. The lifetime allowance is an overall aggregated allowance of the amount of UK pensions a client is entitled to hold at concessional UK tax rates during their lifetime (see Example 3). In Example 3, unless John was locked into fixed protection, on transfer after 6 April 2016, the reduction in the lifetime allowance could create an extra tax liability on transfer of £62,500. This needs to be properly factored into the current UK tax year’s advice.
When considering the taxation of death benefits from pension schemes, it is essential that jurisdictional differences are properly allowed for. This encompasses not only the payment of any capital or residual benefits, but also the situation with regards to protection of the client’s estate from any carry over of UK inheritance tax, or the imposition of local death taxes and duties.
Complex issues
This article accentuates the complexity and some of the many international factors that need to be considered when deciding whether a UK defined-benefit pension transfer to a ROPS is in a non-UK resident client’s best interests. A projection of benefits cannot be limited to a UK critical yield analysis and associated illustrations.
This decision needs to be properly balanced with the client’s ability to take on the management of investment and longevity risk as well as their own personal circumstances and financial goals.
It is important the appointed adviser has international experience and holds the relevant qualifications to properly handle the considerations when dealing with non-UK resident clients.
Example One
John is 50 years old, resides outside the UK, is a medium-risk investor and has a UK defined-benefit pension. John can transfer his pension for a cash equivalent transfer value (CETV) of £320,000, or receive a pension from his UK scheme currently valued at slightly less than £12,000 pa (£16,000 pa from age 60). A standard UK critical yield analysis provides an outcome of approximately 7.5% pa. The scheme is contracted-in, has 3% pa revaluation and escalation rates, 50% spouse’s pension and a five-year guarantee. John retires at 60, lives to age 90 and outlives his spouse. Adviser remuneration has not been allowed for, although this should be included in the final analysis and decision-making process.
Scenario 1 Scenario 2
Post tax pension from age 60 £8,800 pa £8,800 pa
Total payments received pre-tax £800,000 £440,000
Total payments received post tax £440,000 £440,000
NPV* post tax payments £273,000 £273,000
Capital value of benefits at 90 Nil £420,000
(*NPV = net present value. Discount rate assumed 3% pa. Assumed growth rate on fund invested is 3% pa post fees and charges. Escalation rate of 3% pa. Some rounding of figures has been allowed for.)
Example Two
Consider John’s CETV of £320,000, allowing for growth of 5% per annum in the UK on an alternative pension product and comparing this to a rate of pension growth abroad of, say, 6% per annum, that is, if John transferred his UK pension to another jurisdiction to accrue in the run-up to retirement age.
John’s projected pension comparison (pre fees and charges and taxation):
Scenario 1: UK Scenario 2: abroad
CETV at age 50 £320,000 £320,000
Growth rate assumed 5% pa 6% pa
Fund value at age 60 £521,000 £573,000
Example Three
Assume John has a fund valued at £1.25m, has not crystallised any benefits and has no lifetime allowance protection in place.
On transferring a pension from the UK, benefit crystallisation Event 8 occurs, which serves to tax any excess above the lifetime allowance at 25%.
Date Pre 6 April 2016 Post 6 April 2016
Lifetime allowance limit £1.25m £1m
Assumed CETV £1.25m £1.25m
Tax on full transfer abroad £0 £62,500
