Pension lifetime allowance charges and whether they will affect you
5th May 2023
Posted in Articles by Michael Hodgson
The issue
The removal of lifetime allowance (‘LTA’) charges in pensions means that people can now contribute more into their pension fund than the previous £1.07m limit (there is currently no limit). However, with modern day yo-yo politics and the promise a future Labour government will reverse the change, many people are hesitant to take advantage of this opportunity in fear of future changes (which could amount to retrospective taxation). Could Qualifying Recognised Overseas Pension Schemes (‘QROPS’) be the solution?
Qualifying Recognised Overseas Pension Schemes (QROPS)
QROPS are recognised overseas pension schemes which are able to receive a UK tax-free transfer from a registered UK pension. The schemes were originally designed for individuals who had accrued UK pensions and had decided to retire overseas but they are also technically available to UK residents who have no intention of relocating. Most QROPS operate very much like a UK pension fund and offer the same tax benefits and flexibility.
A transfer to a QROPS is a ‘Benefit Crystallisation Event’. Under the old rules the pension fund needed to be valued and measured against the lifetime allowance at the point of transfer. Once the funds had been tested on transfer, there were no further tests inside a QROPS and therefore no future LTA charges could arise. Within a UK scheme the LTA generally also needs to be tested when the member of the scheme starts to drawdown his pension or reaches the age of 75.
Given that there would be no charge on a transfer to a QROPS now, this could be seen as a mechanism to lock in the favourable LTA position that currently exists.
Case study
The facts are as follows:
Mr Starmer is a UK resident individual with a UK pension fund of £2,000,000.
He is 54 years old and is not planning to retire until age 65.
He knew that under pre-6 April 2023 pension rules, a £2m pension would suffer LTA charges of up to £510,000 (55% of excess over Standard Lifetime Allowance) and so was very happy that the LTA limits had been abolished.
He believes that a future Labour Government will reverse the changes and leave him with a £510k charge in 11 years’ time.
He decides that crystallising the pension in the current tax year is the best option to protect against the possibility of future LTA charges when he begins to drawdown on his pension and/or reaches the age of 75. He is not yet 55 years old and so cannot transfer the fund into flexible drawdown (a crystallisation event). He therefore decides to transfer the fund into a QROPS as he knows that this will also crystallise the fund. As there is currently no LTA charge, the transfer of the £2m pension fund can be made without consideration of the old £1.07m limits. Furthermore, no further crystallisation event can occur and so Mr Starmer has avoided any LTA charge for good. QROPS also receive all the same tax advantages and can be managed the same way by his fund advisors.
11 years later, Mr Starmer decides to retire by which time Labour (under his stewardship!) has reinstated the LTA charge. However, QROPS are not governed by UK legislation and so the charge does not apply to Mr Starmer. He will therefore have avoided the LTA charge.
Forbes Dawson view
The promise of a Labour reversal and the constant U turns within the current government, means that individuals with pension funds significantly in excess of £1m should seriously consider striking while the iron is hot and locking in the LTA. Of course, this is all speculation and there is a chance that the LTA will never be reinstated. Also, great care should be taken to properly implement any transfer to a QROPS (and I suspect that Mr Starmer may have faced some political fallout in the above example! – which is purely fictional).
