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), Portugal for instance, 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, all types of approved schemes have the same tax treatment.
Even if you are not a UK resident, you will be taxed on income that originates in the UK – for example a UK-based pension – which will be 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 (DTAs), with the UK. If you are a resident of one of these countries, such as Portugal, you will be taxed only in your country of residence except under certain circumstances.
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 resident of Portugal, 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.
Both Malta and Gibraltar are attractive choices for a QROPS transfer because they offer very favourable terms.
Pension Plans Transferred to a Malta QROPs
There is a Double Tax Agreement between Portugal and Malta so that pension payments are taxed only in the country where the individual is resident. 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.
Pension Plans Transferred to a Gibraltar 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.
Income Tax Rule for Portugal Residents and Portugal Source Income
Residents in Portugal for tax purposes are taxed on their worldwide income at progressive rates varying from 13.25% to 48% for 2024. An additional solidarity rate, which varies between 2.5% and 5%, applies to taxpayers with a taxable income exceeding EUR 80,000 and EUR 250,000, respectively.
An individual is a resident of Portugal if he was residing in Portugal for more than half of the calendar year. In any year in which an individual has residential accommodation in Portugal on December 31st, he is considered a tax resident for that year.
Non-Habitual Tax Residents
Some individuals may have qualified for a special regime known as the Non-Habitual Tax Residents (NHR) regime which offered reduced tax rates to individuals who relocated to Portugal (subject to meeting certain residence conditions) and had not been resident in Portugal in the last five years.
However, the Portuguese Government announced the end of the Non-Habitual Residents regime from 1 January 2024, which means that individuals looking to relocate to Portugal will no longer be able to access the special tax regime unless they meet the relevant conditions and hold a valid residence visa as at 31 D