Beware overseas pensions

People moving abroad can take their pension assets offshore with qualifying recognised overseas pension schemes (QROPSs). These arrangements have been in the news recently as a tax mitigation device at a time when public concern about tax levels is rising.

The big advantage of QROPSs is that, once five years have elapsed after a scheme has been set up and the investor has been registered as a non-UK resident, the arrangement is free from UK regulations and tax.

This means pension benefits can be paid gross, which could significantly boost your pension income in a low-tax regime, such as those of Malta and Cyprus.

Death benefits from QROPSs are more tax-efficient than they are from a UK pension. The fund will be returned on death without an unauthorised payments charge or inheritance tax liability, although estate charges in the country of residence may apply.

This compares favourably with a UK pension, where current rules force people to buy an annuity by the age of 75 (or pay a tax penalty on death), so that nothing is left to pass on to heirs.

But it's not as easy as that...

One major problem people retiring abroad face is currency risk. A QROPS can be invested in non-sterling assets, mitigating the conversion risk involved in receiving a pension in sterling when day-to-day outgoings are in another currency.

Currencies can move against each other dramatically - in the past three years, the value of sterling has fluctuated by more than 30% against the euro.

Transferring to a QROPS is not a step to be taken lightly. They are expensive and not generally recommended for funds of less than £200,000.

According to Graham Barnes, international director at The Fry Group, typical set-up costs are around £1,500, plus an annual charge of £1,000 to £1,500 payable to the trustees, and that's before the chosen asset manager deducts annual management fees.

Some advisers like to sell QROPSs for the wrong reasons. For example, a QROPS will put an adviser in a position to advise on a client's pension assets, wherever they currently live or move to, and until the Financial Services Authority's retail distribution review comes into effect on 1 January 2013, advisers can still take upfront commission on the underlying investments.

Make sure your scheme qualifies

Another concern with QROPSs is that in some cases HM Revenue & Customs has revoked QROPSs' qualifying status. In September, members of the Beazley Consulting Pension Scheme in Hong Kong discovered that they could lose 55% of their savings, after the scheme's status was revoked. This will consist of an unauthorised payment charge of 40% and a 15% surcharge.

Even more disconcerting, the latest QROPS list, published by HMRC on 3 September, includes a scheme about to lose its approval, so even HMRC's list is not a definitive guide.

Barnes says such cases occur because a few schemes have broken the fundamental rules of pensions, by allowing 100% cash commutation, for example, while some wait the statutory five years and then start to bend the rules. "It needs to be a pucker pension, in a jurisdiction with proper pension regulations and be on HMRC's list," he says.

"I have some sympathy with the Revenue on this. A pension is tax-free on the way in, and then you generally take the income taxed at source, but people are trying to take the income out tax-free."

Most advisers suggest you only take out a QROPS if you expect to become a non-UK resident within 12 months. "QROPSs absolutely make sense for people genuinely planning on retiring abroad and who want to retain control of their pension outside the UK's tax system," says Tom McPhail, head of pensions research at Hargreaves Lansdown.

"For anyone who might have been contemplating using a QROPS, even though they were planning on staying in the UK, there are a couple of reasons to think again. HMRC is clamping down on anything that smacks of avoidance, and UK pension investors deliberately moving their savings offshore is not the kind of thing it finds amusing."

Transfers from personal pension schemes and final-salary schemes (defined benefit) are permitted, but the latter may be inadvisable. If you are a member of a final-salary scheme, you will need to factor in potential benefits, such as a widow's or widower's pension and guaranteed future increases in line with inflation, which will mount up.

This article was originally published in Money Observer - Moneywise's sister publication - in November 2010

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