Getting two bites of the tax-free cash cherry

In a matter of weeks, we will have a new pensions tax regime. As we pore over the latest rules and guidance, one area that has caught advisers’ (and their clients’) attention is overseas transfers.

At one time, transfers to QROPS (qualifying recognised overseas pension schemes) were a considered financial planning strategy. But in recent years, the number of transfers has fallen sharply. In 2014-15 there were 20,100 transfers totalling £1.76 billion of pensions wealth. This fell to only 3,300 last tax year representing £680 million.

The introduction of the overseas transfer charge in 2017 was an obvious tactic by HMRC to put a stop to the number of transfers. Which makes it all the stranger that the new tax rules may resurrect interest in this area.

‘Double dipping’

As well as the Lump Sum Allowance (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA) limiting tax-free lump sums in life and on death, there is a third new allowance – the Overseas Transfer Allowance (OTA).

This is set at the same level as the member’s LSDBA. A client can transfer to a QROPS without a 25% overseas transfer charge if it meets the usual rules for QROPS transfers (set out in 2017) and the amount transferred is less than their OTA.

The OTA is separate from the other two allowances. If a client uses up some of their OTA by transferring overseas that won’t affect the LSA or LSDBA left in the UK.

Therefore, clients with allowance-busting pension wealth should be able to transfer the excess overseas testing it against their OTA and as long as it’s under £1.073 million (for most people) then there won’t be a charge. They can then take benefits from those funds, including tax-free cash where rules allow. They can also take tax-free cash from their UK funds up to their LSA of £268,275.

This gives these clients two bites at the tax-free cash cherry.

Financial objectives

A note of caution: before rushing in individuals should consider their overall objectives.

They may get be able to boost their tax-free cash, but it will mean taking money out of the inheritance tax (IHT) sheltered pension and moving it into their estate. Clients need to have a plan on what to do with this money, especially if the individual is already concerned by IHT. £536,000 is a lot of money to either spend or gift to others. Although, withdrawing tax-free cash in stages over several years may help to spread the IHT risk.

If cash isn’t the main driver, then clients may want to question why they want to transfer. They may be concerned their pension funds exceed their LSDBA when tested on death before age 75. But only lump sums are tested, not income. As long as beneficiaries have access to income drawdown then there’s no need to transfer overseas to dodge the LSDBA.

Complicated transfers

Transfers to QROPS are not straightforward and there are many areas to consider. The rules governing the OTC means it’s easy for clients to trip up and fall foul of the 25% charge. They also need to think through the full implications of receiving pension benefits from overseas schemes, including coping with different tax rules, and the taxation of the countries they are resident in and of the one the scheme is established in. They may also have to navigate communicating in a different language, as well as any currency risk. None of this is simple and needs specialist help.

In addition, often QROPS transfers will be costly, and individuals may not have access to a compensation scheme should things go wrong.

In flight angst

A transfer can only go ahead if the (recognised overseas) pension scheme is a ‘qualifying’ one. Following the change in pension tax rules, HMRC will be looking for confirmation from QROPS they have made any appropriate changes, and some schemes may ‘fall off’ the ROPS list HMRC publishes twice a month.

There is no provision for ‘in flight’ transfers if that happens. In those circumstances it’s a case of if the name isn’t down, you’re not getting in. The transfer would have to come to an abrupt halt and all the work and expense in getting to that position would be in vain.

Too good to be true?

These new rules have the potential to shake-up the QROPS transfer market. Especially as the disquiet caused by Labour’s vow to reverse the lifetime allowance abolition has financial advisers and clients on edge looking for ways to avoid a retrospective or new tax.

However, encouraging QROPS transfers goes against the grain of the last seven years and the introduction of the OTC. It also goes against the overall government ‘Mansion House Reforms’ policy of encouraging pension schemes to invest in the UK.

Instead, this has a whiff of an unintended consequence. Advisers and clients should probably keep a close eye on future changes to the rules and guidance to make sure this remains unchanged in the long term.