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Tax treatment of UK pension payments

Pension payments in the UK are taxed as earned income in most cases 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 reclaim the tax paid in the UK.

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. The gross pension income can then be declared in Germany in the usual way.

Death benefits and their tax treatment

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.

However, if you accept a transfer value and move your 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 removes the effect of the UK Lifetime Allowance (LTA) which places a limit (currently £1.03m) on the total value of your pension fund – with any excess being taxed at 25% or 55% depending on how the benefits are taken. This is often an important point for those with large pension funds.

In order to better protect your pension payments from UK tax, you may decide to take advantage of QROPs rules and transfer your pension to another jurisdiction – this need not be your country of residence. Both Malta and Gibraltar are attractive choices because they offer very favourable terms and any lump sum death payments can be free of UK tax as outlined above.

QROPS - Malta

There is a DTA between Germany and Malta so that pension payments are only taxed in the country where the individual is resident. Under the DTA, income payments from a QROPS pension based in Malta would therefore not be taxable in Malta.

QROPS - Gibraltar

The position for Gibraltar is slightly different as there is no DTA between Germany and Gibraltar. Pension payments would be taxed at the current rate of 2.5% in Gibraltar and the appropriate rate in Germany. However, foreign tax credits would be available for the Gibraltar taxes paid on income so the net tax effect is the same.

In summary, the advantages of a QROPS based in either Malta or Gibraltar are:

  • Gross payment of pension income (except for the above 2.5% tax in Gibraltar)
  • Freedom from the effects of the LTA
  • Flexible benefits – you can take cash or regular payments at a rate and time to suit your financial circumstances (subject to some limits in Gibraltar)
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