Tax treatment of UK pension payments
‘Is my UK pension taxed in Germany?’ can often be heard uttered by many a Germany based Brit. Pension payments in the UK are, in most cases, taxed as earned income, and German residents who have pensions payable from the UK may find that they are taxed twice – once under the UK PAYE system and again in Germany.
However, Germany, in line with many other European countries, has a Double Taxation Agreement (DTA) with the UK whereby a German resident can take their pension in Germany and reclaim the tax paid in the UK. Although the agreement is extended to various countries, it can effectively be considered, in this instance, a UK-Germany tax treaty.
A simple way to avoid having to keep reclaiming overpaid UK tax is for the member to apply for a UK “NT” tax code which allows the UK scheme to make the payment without any tax deduction – essentially acting as a UK pension transfer to Germany. The gross pension income can then be declared in Germany in the usual way.
Death benefits and their tax treatment
If you have a UK Defined Contribution (DC) scheme (eg a SIPP or Personal Pension), the benefit payable on death to your beneficiaries is usually the value of your fund at the date of death. If you have deferred benefits in a UK ‘defined benefit’ scheme (often referred to as a ‘final salary’ scheme), it is not possible for your family to receive the capital value of your pension on your death – a dependant’s pension is usually payable instead which is taxed as earned income. I
However, if you accept a transfer value and move your Defined Benefits to a ‘defined contribution’ arrangement – a QROPS for example – then the whole value of your pension fund can be passed to nominated beneficiaries on your death. This is often a very important consideration for those who have been offered high transfer values.
In general terms, both lump sum and income payments from a QROPS will be free of UK tax if the member dies before age 75, providing any lump sum is paid out within two years of death.
However, if the member dies after age 75 then different rules apply. Marginal rates of UK tax will apply to all payments unless
• The beneficiary is non-UK resident and
• The member was not UK resident in any of the last 10 consecutive years and
• The member did not transfer within five years of death.
Even if none of the above restrictions apply the beneficiary may still be taxed in his country of residence on any lump sum or income payment so it is essential to take independent tax advice on the tax status of any such payments.
Considerations for transferring your defined benefit arrangement to a QROPS
• A Qualifying Recognised Overseas Pension Scheme (QROPS) normally pays retirement income without any tax being deducted at source although there are some exceptions.
• It is possible to pass the entire value of your pension fund to members of your family, in some cases free of UK tax – but please note the comments above.
• A transfer to a QROPS, for a German resident, removes the effect of the UK Lifetime Allowance (LTA) – see below – which was set to be abolished in the Spring of 2024.
The Lifetime Allowance (LTA)
A major reason to transfer to a QROPS was the Lifetime Allowance (LTA) which imposed a limit of £1.73m on the total ‘tax-privileged’ amount you could hold in your pension fund.
Any fund in excess of this amount would be taxable at 25% (or possibly 55% if you took the excess amount as cash). A transfer to a QROPS would remove any future liability to the LTA .
The Spring Budget 2023 abolished the tax on any excess funds with the LTA itself due to be abolished in April 2024 which means that one of the main reasons for considering a transfer to a QROPS has now diminished in importance.
However, the Labour Party has said that if it wins the next General Election, it will reintroduce the LTA. This means that there may still be a case for transferring to a QROPS if you have a fund in excess of the LTA or if it is likely to be so by the time you retire.
Overseas Transfer Allowance (OTA)
You may think that because the LTA excess charge has been abolished, you can ‘crystallise’ (transfer) your UK funds to a QROPS with no charge even if you are over the current LTA of £1.73m. However, the Government has introduced a new charge known as the Overseas Transfer Allowance (OTA). The charge is 25% of the excess over £1.073m for any transfer from a UK scheme to a QROPS. A transfer to another UK arrangement – such as to a SIPP or another Personal Pension – is exempt.
However, you could still give serious consideration to a transfer to a QROPS even if your fund is in excess of the OTA. The reason for this is simple – any excess charge will simply increase over the years as your fund grows. You may wish to rid yourself of any future potential liability by transferring to a QROPS sooner rather than later
The information contained is based on current legislation which is subject to change