QROPS no longer enjoy any increased tax benefits or additional flexibility than a UK SIPP for anyone who is UK resident. Both will be within the estate for IHT. So should clients with a QROPS who are UK resident bring their pension back home? The Aberdeen technical team looks at the issues and advantages of doing so.
Qualifying Recognised Overseas Pension Schemes (QROPS) have suffered a further blow with the draft pensions and IHT rules confirming they will fall within the estate for IHT from April 2027 for anyone who is long term UK resident. But while IHT liabilities on pension death benefits arising from UK pensions can be settled directly with HMRC, this will not be an option for QROPS.
This follows quickly after HMRC removed the exemption from the 25% Overseas Transfer Charge (OTC) for transfers made to the EEA or Gibraltar where the member remains UK resident. This exemption had been exploited to get potentially two bites at the tax-free cash cherry as the transfer wasn’t tested against the member’s lump sum allowance.
These latest clampdowns have removed any benefit from transferring overseas while remaining UK resident. In fact, the balance has swung so far that those that have already transferred to a QROPS or have simply accrued overseas pension savings while working outside the UK may now need to consider bringing those pension savings back to the UK and under advice.
Impact of the new IHT rules
With pensions coming within the IHT net from April 2027, some clients may have concerns over transferring overseas pensions to the UK. However, QROPS will face the same IHT treatment as UK schemes for long term UK resident clients. The draft legislation confirms that QROPS, which fall within the wider definition of qualifying non-UK pension schemes (QNUPS), are included within the estate for IHT purposes. Transfers to a UK scheme should not materially change the IHT liability for any clients who intend to remain UK resident.
Clients retiring abroad will remain subject to UK IHT on their worldwide assets for a period after leaving the UK if they have previously been UK resident for 10 out of the last 20 tax years. For someone who has always been UK resident, it will take up to 10 years from becoming non-UK resident for a QROPS scheme to be outside their estate for IHT once the new rules come into play.
The executors of UK resident clients who continue to hold a QROPS scheme at their death will have to deal with the overseas scheme, along with any UK pensions, when determining any IHT payable.
Additionally, the option for any IHT due on unused pension funds to be paid directly to HMRC will only apply to UK registered pension schemes. This means any IHT payable in respect of the QROPS must be paid either by the beneficiary who receives the death benefit, or from the free estate with the executors potentially having to reclaim this from the beneficiary.
HMRCs constant battle to close loopholes
QROPS were introduced to allow those retiring overseas to take their pension with them. However, over the years, successive governments have had to tinker with the rules due to concerns that loopholes had emerged, leading to QROPS often not being used for the purpose intended.
Prior to 2015, some UK residents transferred their pension funds to QROPS to avoid having to buy an annuity or being restricted by the capped drawdown limits.
Of course, pension freedoms have since removed those restrictions. Members of schemes offering drawdown can draw as much or as little as they want from their pension, whenever needed.
Before the removal of the lifetime allowance (LTA), some UK residents with pension funds which exceeded – or were likely to exceed – the LTA, transferred some or all of them to a QROPS to avoid, or minimise, an LTA tax charge. Although the transferred pension funds were tested against the LTA at the time of transfer, any growth on those funds would not result in further LTA tax charges.
With the LTA now abolished, LTA tax charges are no longer relevant. Overseas pensions transferred to a UK registered scheme will be tested against the lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA) in the usual way when relevant lump sums are paid. It’s worth remembering that tax-free cash taken from an overseas scheme prior to the transfer will not count towards the LSA and LSDBA.
Any potential issue with exceeding the LSDBA on death before age 75 can be avoided by using beneficiary’s drawdown, as this is not tested against the LSDBA.
Additional tax-free cash opportunity
Previously, some individuals were able to get extra tax-free cash (potentially double) by transferring out to a QROPS while remaining in the UK.
Following the removal of the LTA, pension funds transferred to QROPS were tested against the new overseas transfer allowance (£1.073M for those without transitional protections) – but, crucially, not the LSA or LSDBA.
Normally, if a transfer is being made to a QROPS but the member is not resident in that country, there would be a 25% overseas transfer charge (OTC) levied on the transfer value. However, there was an exemption if the transfer was being made to QROPS in the EEA or Gibraltar and the member was resident in the UK or the EEA. This exemption opened up the opportunity for additional tax-free cash by transferring to a QROPS in one of these territories, with both Malta and Gibraltar providing an active market for this type of transfer.
This exemption from the OTC was withdrawn from 30 October 2024, closing the loophole.
Some clients may have transferred to a QROPS to increase the overall of tax-free cash available. If they’ve already taken the tax-free cash from their QROPS, they can transfer the crystallised funds back to the UK without it affecting the tax-free cash entitlement on their UK pensions. That’s because tax-free cash taken from the QROPS doesn’t reduce the client’s LSA or LSDBA.
Why bring QROPS back to the UK?
There are some obvious benefits of UK residents transferring their overseas pensions to the UK:
- Brings all retirement savings under advice.
- Simplifying pensions – it’s easier for clients and advisers to deal with providers in the same country and monitor their performance.
- No issues with currency conversion for any ongoing withdrawals. Of course, there will be a conversion at the time of transfer.
- No need to worry about claiming double taxation relief, if indeed any exists.
- Often lower fees and more transparent charging structures compared to QROPS.
Establishing if the client is likely to remain in the UK is an obvious starting point. If the client intends to move abroad to retire – particularly if this is soon – then there’s probably little sense in transferring their overseas scheme(s) to the UK.
Before confirming a transfer, it’s always worth checking with the provider of the transferring scheme if there will be any tax implications of transferring the benefits to a UK registered pension scheme, or if there are any valuable guarantees that could be lost.
As touched upon earlier, if a client’s overall tax-free cash entitlement could be restricted by the LSA, taking tax-free cash from an overseas pension can help. Any tax-free cash taken from the overseas scheme doesn’t reduce their LSA or LSDBA. They are then free to transfer the crystallised funds back to the UK without affecting the tax-free cash that can be taken from their UK pensions.
And looking further ahead, transferring to a UK SIPP and bringing overseas pensions under advice can make the payment of death benefits and the settling of IHT liabilities less stressful for the executors.
