A secure future

Adam Wrench assesses the issues advisers need to bear in mind when looking at the QROPS market

Recent moves by HMRC to close loopholes in the legislation affecting QROPS has led to concerns that the product is no longer a safe way to take retirement income.

In April, HMRC introduced a clause in the Finance Bill to close a tax loophole created by a new double taxation treaty with Hong Kong, which allowed UK residents to pay lower tax on pension income than would apply in the UK.

The loophole had arisen because certain double taxation agreements between the UK and offshore jurisdictions allowed UK residents, with a QROPS registered in such jurisdictions, to draw pension income at the rate applicable in the country where the QROPS is registered, which in the case of Hong Kong is up to a maximum of 17%.

HMRC’s action was to ensure that people do not use QROPS to avoid paying the right level of tax within the UK.

It will therefore affect anyone who has taken out a QROPS in an overseas jurisdiction, where there is a double taxation agreement that allows them to pay income tax at a lower rate than that applicable in the UK.

What does this mean?

This means that where there is a double taxation agreement in place between the UK and another country, payment of a pension would be taxed in the UK under the following circumstances:

• where the payment arises in the other territory

• where it is received by an individual resident of the United Kingdom

• where the pension savings, in respect of which the pension or other similar remuneration is paid, have been transferred to a pension scheme in the other territory.

• where the main purpose, or one of the main purposes, of any person concerned with the transfer of pension savings in respect of which the payment is made, was to take advantage of the double taxation arrangement.

Where QROPS are found to have broken or abused HMRC rules, providers could be disqualified and a tax charge applied to the member’s pension fund of 55% to 82%, with implications for other members within the same scheme.

This means that financial advisers must conduct comprehensive due diligence, both on the QROPS provider and the retiree’s circumstances in particular, the retiree’s current country of residence, their future residency plans and the existence of any double taxation agreements which might affect the member’s tax position, both now and in the future.

The jurisdiction in which the QROPS is registered will be crucial. Retirees should also be warned that, if they, or their spouse, is drawing from their QROPS and return to the UK after retiring, then UK pension regulations will come into force and QROPS advantages will be lost.

Is the end nigh?

So does HMRC’s clampdown spell the end of QROPS as an attractive way for individuals who are living abroad, or who intend to retire overseas, to take their pension income? Certainly not.

QROPS continue to enjoy numerous advantages such as the facility for members to hold their investments in the currency of their country of residence, enabling them to draw their retirement income in that currency, eliminating the currency risk and foreign exchange charges which would apply to taking payments from a UK-based pension fund.

Expats who reside outside the UK for five whole financial years following the transfer of their UK pension, can enjoy tax advantages, such as income paid gross in jurisdictions where there is no double taxation agreement with the UK.

The income is then taxed at the rate applicable in the retiree’s country of residence. A 25% tax free lump sum can also be taken and up to 30% may be allowed.

This enables retirees, who have accumulated pension savings with the benefit of 40% (and now 50%) tax relief, to arrange to take income from a QROPS in the tax regime of their domicile, possibly at a significantly lower rate than would be payable in the UK.

Once a client has been non-UK resident for at least five years, QROPS are no longer subject to UK GAD rates, enabling a higher annual income to be taken.

Another advantage is the facility for the retiree to pass their entire residual pension fund to their beneficiaries on death.

While QROPS are likely to remain under scrutiny by HMRC for some time to come, advisers who conduct the necessary due diligence and have a thorough understanding of their clients’ future plans can still deliver significant benefits for those wishing to spend their retirement years abroad.

Adam Wrench is product development director at London & Colonial