Originally published in Investment Week, 13 December 2010

Over the past 10 years or so HMRC has been introducing restrictions that limit tax reliefs given to registered pension schemes. It is now debatable whether registered pension schemes in the UK should continue to be the only or main planning tool for senior executives and high earners in their retirement planning says Stephen Collier, Client Services Director at Mercator Trust Company in Guernsey.

For many years the UK Government has encouraged UK resident individuals to save for their retirement through the use of regulated retirement schemes by giving the individuals tax relief on contributions made into the retirement scheme, and allowing the pension funds to grow in a tax efficient environment until benefits are drawn after retirement.

The tax reliefs were generous and on the back of this most pension savings were via regulated pension schemes which now hold many billions of pounds of investments.

However, HM Revenue & Customs ("HMRC") has over the last 10 years or so been introducing restrictions which limits the tax reliefs given to registered pension schemes and for the senior executive or high earner, it is now debateable whether registered pension schemes in the UK should continue to be the only or main planning tool of senior executives and high earners in their retirement planning.

There are new pension savings options available to individuals who still want to save for their retirement, for example Employer Funded Unapproved Retirement Benefit Schemes commonly referred to as EFURBS, but this is not the case for those individuals who have left the UK already. These non-UK resident individuals who have left the UK, for instance because they have emigrated abroad or who were only in the UK for a number of years and have now left the UK, had limited options until 2006 and as a result they would probably have had to suffer the UK tax charges on their registered pension fund unnecessarily.

The restrictions imposed by HMRC which are of significance to the non-UK resident individual, include:

  1. Annual and Lifetime allowances have been introduced to ensure that pension pots do not grow too large e.g. the tax charge on an excess over £1.5m can now be as high as 55%
  2. Where a purchased life annuity is not bought from a life assurance company and the individual dies, the combined pensions tax and inheritance tax charges can amount to 82% of the pension fund. Under the new proposals the Tax Relief Recovery Charge would amount to 55%
  3. The choice of how to invest the pension pot is firmly restricted to retail style investments which limits any entrepreneurial aspirations of the executive

The UK pensions industry experienced a significant reorganisation with the advent of A-Day in 2006 and one of the measures introduced at that time was the Qualifying Recognised Overseas Pension Scheme, referred to as QROPS.

The QROPS is an overseas pension scheme and is suited to individuals who have either already left the UK, or are about to leave the UK. To qualify as a QROPS with HMRC, the provisions of the pension must be acceptable to HMRC and assuming they were, HMRC will allow the funds in the UK pension to be transferred to the QROPS with no immediate UK tax charges.

A QROPS has to be managed by a trustee, and this trustee must ensure that the scheme is moving into a qualifying QROPS and has also been approved by the local Income Tax department. If an individual is moving back to the UK then the QROPS can be retained depending on its technicalities and should be judged on a case by case basis.

Following well documented problems with some offshore centres such as Singapore, Guernsey has become the leading QROPS jurisdiction by proactively developing a good relationship with HMRC, ensuring that the structures are run in the spirit of the UK legislation. The Guernsey regulator has also been active in this area ensuring that the providers of trustee services are appropriately regulated, qualified and kept well informed. The Guernsey QROPS are usually modelled on the Retirement Annuity Trust that has been available to Guernsey residents for many years, and as a result of this, Guernsey QROPS are able to pay benefits without any Guernsey income tax deductions to non-Guernsey residents. This is a considerable advantage to some other jurisdictions where tax deductions are mandatory.

There are significant benefits for the non-UK resident to hold their pension monies in the QROPS, and in brief terms these are:

  1. Annual and Lifetime allowances do not apply so funds can grow freely and not be subject to the above high tax charges
  2. The QROPS pension fund should not be subject to the above pension tax charges, UK income tax or UK Inheritance tax, and therefore the funds can be left to the family of the executive tax efficiently
  3. Pension benefits will be paid by the QROPS with no local withholding taxes, so that the individual will only be taxed by their home jurisdiction
  4. Investment of the pension pot is very wide, thus allowing for entrepreneurial proposals
  5. There is no requirement for the individual to be resident in the jurisdiction of the QROPS provider, which could for example be in Guernsey which is the market leader.

As you would expect, HMRC has introduced safeguards to ensure that the QROPS provisions are not abused, and there is a reporting requirement that every QROPS trustee must agree to, and in broad terms for the five years after the individual has left the UK, the trustee must report to HMRC any benefits that were paid to the individual. The penalty for non-compliance is the non-authorised payment tax charge, and this can be up to 55%.

Therefore a UK regulated pension scheme for a non-UK resident individual exposes that individual to some penal UK taxes that may otherwise be easily avoided if those funds were transferred into a QROPS. The pension scheme arrangements for someone leaving the UK are commonly overlooked as the main taxes (income tax, capital gains tax and inheritance tax) are focused upon by their advisors, but as the UK taxes which are imposed on the UK pension plan can be significant, advisors should now include these in their reviews.

A QROPS case study

Peter is 75 years of age and after working for many years in the UK motor industry he left the UK permanently around five years ago due to poor health, and now lives in Barbados.

The UK pension entitlement that he built up over his career is held in a UK pension SIPP as he has a keen interest in investment matters and likes to choose how the fund is invested. The fund is currently worth approximately £2m and he is drawing a monthly pension income in line with UK GAD rates. His IFA advised that he elect for enhanced protection a number of years ago, which he duly did.

During a routine annual meeting with his IFA, Peter mentioned that he had recently suffered a minor stroke and he wondered what UK taxes would be due if he were to die. The IFA had explained that if he were to die whilst the pension fund was still with the UK SIPP, the new 'tax relief recovery charge' would amount to 55% of the Fund, i.e. £1.10m, which would leave a fund of just £900k for his family to benefit from.

Naturally, Peter was very concerned with this and asked if there was anything he could do to mitigate this tax liability. The IFA advised that Peter might like to consider transferring his UK Pension Fund to a QROPS.

As Peter has already elected for enhanced protection on his pension fund, the fund could be transferred to the QROPS with no UK pension or IHT charges. Once within the QROPS he could still enjoy SIPP type powers over the investment strategy of the Fund, and continue to draw a monthly pension income during his lifetime. The main difference would be that on his death there would be no UK pension tax, tax relief recovery charge or inheritance tax. Therefore the entire £2m fund would be available to benefit his family and dependants giving a real and worthwhile substantial tax saving of £1.1m.

Peter was relieved to hear this and took steps to immediately arrange for the transfer of the pension fund to a Guernsey QROPS provider that his IFA recommended.

For more information about Guernsey's finance industry please visit www.guernseyfinance.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.