Lump Sum Death Benefits Tax: A common mistake UK ex-pats often make in pension planning.
It seems that many UK ex-pats often make the mistake of assuming that inheritance tax will not apply to any lump sums left in pensions after death. Although Inheritance tax does not apply to UK pensions, (it applies to other inherited assets) many people are unaware that another tax is applied upon death; Lump Sum Death Benefit Tax and that this tax can be as high as 55%!
Inheritance tax and Lump Sum Death Benefit tax are not the same, although they share similarities. With standard UK personal pensions, if the member dies before taking a retirement income, or before the age of 75, no tax is due. On death after retirement, a spouse or financial dependant may be able to continue drawing a pension income, but if a lump sum is left to beneficiaries after retirement or after the age of 75, the Lump Sum Death Benefit tax of 55% would apply – although this is deducted at source by the Scheme Administrators.
Whilst UK based pension schemes fall under UK regulations and UK taxation, a Qualifying Recognised Overseas Pension Scheme (QROPS) is an overseas pension scheme. Transferring a UK pension fund to a QROPS scheme, for those who are retiring abroad, may be beneficial and more tax efficient.. It’s a great scheme with some outstanding benefits, but with strict HMRC qualifying criteria and with around 2,000 QROPS schemes currently available, choosing the right one for you can be daunting.
Although not falling under UK regulations and UK taxation, a QROPS must meet with certain HMRC requirements, one such benefit is that under certain conditions, is that the whole pension pot can be passed free of tax to beneficiaries of your choosing.
With a QROPS there is also no tax due if the member dies before taking a retirement income. However after retirement, as long as the member has been a non-UK resident for 5 complete tax years, there will also be no Lump Sum Death Benefit tax due (depending on the QROPS jurisdiction). So for certain QROPS members, even after taking a retirement income and as long as they have been living outside of the UK for 5 or more tax years, their pension pot will not be subject to the 55% Lump Sum Death Benefit tax.
If however death occurs before the full five year period, then the 55% tax may be due or if for whatever reason a QROPS holder decides to return to the UK, their pension will revert back to UK regulations.
A major benefit for any QROPS holders returning to the UK is that the 55% Lump Sum Death Benefit tax would usually be calculated from the value at the time the UK pension was initially transferred to the QROPS, so any growth achieved would not be subject to UK tax. The issue of taxation and how it relates to QROPS is complicated.
Don’t make one of the top mistakes, contact one of our financial advisors or download our free retirement planning brochure, alternatively find out everything you need to know about QROPS pensions with our free download guide.