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Pensions that remain in the UK are subject to unique tax liabilities and obligations. Transferring these pensions to another jurisdiction under the Qualifying Recognised Overseas Pension Regime (QROPS) can help you protect your pension funds from double taxation and UK inheritance taxes and charges.

How Your Pension Will Be Taxed in the UK

Pension payments in the UK are taxed as earned income in most cases. Under the current rules established in 2006, all types of approved schemes have the same tax treatment as registered pension schemes. This includes small self-administered schemes, personal pensions, self-invested pension plans, and occupational schemes.

Even if you are not a UK resident, you will be taxed on income that originates in the UK, such as a UK-based pension. UK pension payments are taxed at the individual’s UK marginal tax rate. Currently UK income is taxed up to 45% at the top rate. Some countries have Double Tax Agreements, or DTAs, with the UK. If you are a resident of one of these countries, such as Portugal, you will only be taxed in your residing country except under certain circumstances.

UK Inheritance Taxes IHT

Lump sum payments out of pension plans after death are no longer taxed if the dependants are under 75 years of age, as specified by new rules in 2011. However, there are still many situations when pension payments will be subject to UK inheritance tax or other taxes.

  • If the dependant is 75 years of age or older, lump sums will be taxed at 55%. Lump sums paid after draw-down has started are also taxed at the same rate. In either situation, there is no further inheritance tax liability after the 55% has been paid.
  • Draw-downs received by the dependant after 75 years of age may be subject to a 40% inheritance tax if they are not spent before death.
  • If the death occurred before age 75, and no draw-downs or lump sums had been withdrawn previously, the lump sums after death are not subject to tax.

Double Tax Agreements between the UK and Portugal

The Double Tax Agreement signed with Portugal ensures that pensions and annuities paid in consideration of past employment are not taxed simultaneously by both countries, but only in the country where the individual resides. If you are a tax resident in Portugal, your pension income will only be taxed by Portugal.

Pensions that are not in consideration of past employment are also taxable by Portugal. Government service pensions have separate provisions and rules regarding double taxation.

Transfers to Other Jurisdictions under Qualifying Recognised Overseas Pension Scheme (QROPS)

In order to better protect your pension payments from income tax as well as inheritance tax, you may decide to take advantage of QROPs and transfer your pension to another jurisdiction. Both Malta and Gibraltar are attractive choices because they offer very favourable terms.

Pension Plans Transferred to Malta under QROPs

There is a Double Tax Agreement between Portugal and Malta so that pension payments are only taxed in the country where the individual has residence. It does not matter if the pension is paid in consideration of past employment or not. Under the DTA, payments from a QROPS pension transferred to Malta would not be taxable in the UK or Malta, but only in Portugal. Social insurance pensions and Government Service pensions have different rules and provisions. There are several advantages to transferring your pension to Malta under the QROPS regime:

  • Payments Not Subject to UK Income Tax
  • No Inheritance Tax in Malta
  • xNot Subject to UK Inheritance Tax
  • Not Subject to the 55% Tax for Lump Sum Payments

There are two important exceptions. Obviously, protection from UK income tax only applies if you are not a UK resident, and are instead a resident of Portugal. In addition, the 55% tax on lump sum payments after death will still apply if you have been a UK resident in the 5 years before the payment.

Pension Plans Transferred to Gibraltar under QROPS

There is no Double Tax Agreement between Portugal and Gibraltar, so pension payments would be taxed at the current rate of 2.5% in Gibraltar and the appropriate rate in Portugal. However, foreign tax credits would be available for the Gibraltar taxes paid on income. The advantages to transferring a UK pension to Gibraltar include:

  • Payments Not Subject to UK Income Tax
  • No Inheritance Tax in Gibraltar
  • xNot Subject to UK Inheritance Tax
  • Not Subject to the 55% Tax for Lump Sum Payments

Similar to the transfer of pensions to Malta, these protections only exist if the individual is not a UK resident. The lump sum payments are only protected if the individual had not been a UK resident in the five years before the payment.

Income Tax Rule for Portugal Residents and Portugal Source Income

Residents of Portugal are taxed on their total global income. Income is taxed at progressive rates that go as high as 53%, not including a 3.5% surcharge.

An individual is a resident of Portugal if he was residing in Portugal for more than half of the calendar year. In any year an individual has a residential accommodation in Portugal on December 31st, he is considered a tax resident for that year as well.

Non-Habitual Tax Residents

Some individuals may qualify for a special regime which will make their foreign pension income exempt from Portuguese taxation. Non-habitual tax residency, once granted, lasts for ten years. To qualify, an individual must:

  • Not Have Been Taxed as a Portuguese Resident within the Last Five Years
  • Qualify as a Resident for Each Year of the Ten Year Period
  • Register with the Portuguese Government as a Non-Habitual Tax Resident

Once you are granted non-habitual tax residency, foreign source income will be exempt from Portuguese taxation. Foreign pension income will be exempt as long as:

  • It is Taxable in the Country Where the Pension is Located
  • It is Not Paid by a Portuguese Entity
  • It is Not Paid in Consideration of Employment or Work in Portugal

Generally, UK-based pensions and pensions transferred to Gibraltar or Malta under the QROPS regime will be exempt from Portuguese taxation for non-habitual tax residents. However, if the pension was paid by a Portuguese Entity or paid in consideration of employment or work in Portugal, then it will not qualify for exemption.

Non-Residents of Portugal

If you are a non-resident, you are only taxed on income originating from Portugal. Foreign pension payments that are remitted to Portugal are not subject to tax.

Other Important Tax Considerations

  • Foreign Tax Credits Available for Foreign Tax Paid on Pension Payments
  • When Lump Sum is Greater than Contributions Paid, Pensions are subject to 28% Tax, Whether Foreign or Arising in Portugal
  • No Inheritance or Estate Taxes on Foreign Pension Funds
  • No Wealth Taxes in Portugal

Why You Should Transfer UK Pensions Under QROPS Regime

Although UK-based pension payments will not be subject to UK income tax under the UK/Portugal DTA, they will be subject to the 55% lump sum tax under the UK inheritance tax. The payments will also be subject to the Portugal income tax at rates up to 53%.

Transferring your UK pension to Malta or Gibraltar will protect your pension from the 55% tax on lump sum payments as long as you have not been a resident of the UK for at least 5 years when you receive the payment. Payments will still be subject to Portugal income tax after transfer to either country.

Because of the Double Tax Agreement in Malta, pension payments will not be subject to Malta income tax. However, pensions transferred to Gibraltar will be subject to a 2.5% tax on income (although foreign tax credits are available in Portugal).

If you qualify for non-habitual tax residency, it may be advantageous to apply. Whether the pension is located in the UK, Malta, or Gibraltar, your pension funds will be exempt from income tax in Portugal. Your pension will then be taxable at the lower income tax rates available in the country where it is located. Even with non-habitual tax residency, it is still useful to transfer your pension to Malta or Gibraltar in order to protect your pension from the 55% lump sum payment tax in the UK.

Changes to UK Lump Sum Payment Charge

Taking effect on April 6, 2015, the 55% lump sum payment charge will be lower to 45%. If death occurs before the age of 75, the lump sum payments will not be subject to the tax.

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