UK-based pensions have specific tax liabilities and obligations such as a 45% lump sum death charge. Residents of Spain can take advantage of the Qualifying Recognised Overseas Pension Scheme to transfer their pensions to another jurisdiction and protect them from UK tax obligations.
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 Spain, 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 the UK inheritance tax or other taxes.
- If the dependant is 75 years of age or older, lump sums will be taxed at 45%. 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 45% 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- If the death occurred before age 75, and no draw-downs or lump sums had been withdrawn previously, the lump sums after death are not subject to tax.
A new UK/Spain DTA took effect in 2015. Under this agreement, pension funds are only taxable in the country where the recipient has tax residency. Spanish residents with UK pensions are now only subject to Spanish income tax. This principle also applies to similar remuneration paid to residents of Spain.
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 favorable terms.
Pension Plans Transferred to Malta under QROPS
There is a Double Tax Agreement between Spain and Malta, so that pension payments are only taxed in the country where the individual has residence. Under the DTA, payments from a QROPS pension transferred to Malta would not be taxable in the UK or Malta, but only in Spain. 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
- Not Subject to UK Inheritance Tax
- Not Subject to the 45% 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 Spain. In addition, the 45% 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 Spain and Gibraltar, so pension payments would be taxed at the current rate of 2.5% in Gibraltar and the appropriate rate in Spain. However, foreign tax credits are available for the Gibraltar taxes paid on pension income. The advantages to transferring a UK pension to Gibraltar include:
- Payments Not Subject to UK Income Tax
- No Inheritance Tax in Gibraltar
- Not Subject to UK Inheritance Tax
- Not Subject to 45% Tax for Lump Sum Payments
Similar to the transfer of pension 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 Rules for Spanish Residents and Spanish Source Income
Residents of Spain are taxed on their total global income and are subject to a progressive income tax. An individual is a resident of Spain if:
- Located in Spain for More than Half of the Calendar Year
- Base of His Business, Professional Activities, and Economic Interests is Spain
- Spouse is a Tax Resident of Spain
Non-residents of Spain are only taxed on income originating from Spain and are not taxed on foreign income. Remittances from foreign pensions are not taxable for non-residents.
Special Residency Regime for Expats Relocated by an Employer
Expatriates who relocate to work in Spain may qualify for a special regime in which they can choose between being subject to income tax as a resident or instead by subject to income tax as a non-resident for the year they move to Spain and the next five years. If an individual qualifies and chooses to be taxed as a non-resident, they will be taxed on income originating from Spain at a rate of 24.75% and will not be taxed on foreign income. In this situation, foreign pension payments would not be taxed.
Wealth Taxation in Spain
In Spain there is a net wealth tax with progressive rates ranging from 0.2% to 2.5%. The net wealth tax is applied to total global net worth of Spanish residents and the Spanish net worth of non-residents.
Residents and non-residents are entitled to the following deductions per person:
- Individual deduction - €700,000
Residents are also entitled per person to:
- Main home/permanent dwelling deduction - €300,000. Non-residents, by definition, cannot benefit from a permanent dwelling deduction.
A married couple would each be entitled to the individual deduction as well as the deduction on their share of the main home owned in joint names (residents only).
Also note that this tax is on net assets, which means you can deduct mortgage debts (residents and non-residents alike).
Inheritance and Gift Taxes in Spain
Spanish residents are subject to inheritance and gift taxes at rates from 7.65% to 34%, these are the National rates and these rates do vary depending on the region you live in. Non-residents who receive inheritance or qualifying gifts located in Spain are also subject to tax as above.
Foreign Tax Credit
Tax credits are available for foreign taxes paid on pension income, such as a QROPS pension transferred to Gibraltar.
Why You Should Transfer UK Pensions Under QROPS Regime
UK-based pensions are subject to the 45% lump sum tax under UK inheritance tax. Under the DTA, the pension will not be taxable in the UK as income, but will be subject to Spain income tax at rates up to 53%.
Transferring your UK pension to Malta or Gibraltar will protect your pension from the 45% 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 Spanish 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 granted in Spain).
Even if you are being taxed under the special residency regime and your pension payments are untaxed in Spain, you may still want to transfer your pension under QROPS. Your pension will still be at risk of the 45% lump sum payment death charge if it remains in the UK.