Some clients who move over from the UK may be able to bring their pension benefits with them, but precisely what they will receive in Australia can be a mystifying matter, writes Claudine Siou.
Clients who emigrate from the United Kingdom (UK) to Australia, may have the opportunity to transfer their benefits in a UK-registered pension scheme to an Australian superannuation fund registered as a Qualifying Recognised Overseas Pension Scheme (QROPS).
The decision to transfer the benefits to Australia or leave them in the UK scheme may involve comparing the type of benefits provided by the respective schemes, the tax on the payments as an Australian resident for tax purposes and the social security assessment of the benefits paid from each scheme.
Often, transferring the benefits to Australia may provide significant advantages for the client.
Types of UK scheme benefits
UK registered pension schemes are commonly ‘defined benefit’ or ‘defined contribution’ schemes, although a scheme may offer both a defined benefit and defined contribution arrangement.
Each scheme will have its own specific rules, which must also satisfy any minimum requirements under UK legislation.
Under both types of schemes, it may be possible to receive a ‘tax-free’ (but only under UK tax rules) cash lump sum on commencement of a pension, generally limited to 25 per cent of the total benefits coming into payment. UK rules permit access to pensions from age 55.
UK defined benefit schemes
Member Benefits – Scheme Pension
UK defined benefit schemes are usually employer schemes and provide benefits based on salary and length of service with the employer, in the form of a scheme pension.
A scheme pension is a pension payable for life, at least annually and payments cannot reduce from year to year. Scheme rules may provide for:
- A guaranteed term of up to 10 years, to guarantee payments will continue to any person or the estate (scheme rules permitting), if the member dies within the guaranteed term. If the recipient of the payments within the guaranteed term marries, reaches 18 (in the case of a child) or ceases full-time employment, the scheme rules may require payments to cease. Payments within the guaranteed term cannot be commuted to a lump sum; and
- A guarantee that a set amount of pension will be provided and if the member dies before the guaranteed amount of pension is paid, the balance is paid as a lump sum. This ‘pension protection lump sum’ may be paid to any person or the estate (scheme rules permitting).
If a member dies before they start taking their pension, the UK defined benefit scheme will often pay a lump sum and a dependant’s scheme pension:
A lump sum may only consist of a refund of the member’s contributions (and interest), if the member, when they died, no longer worked for the employer of the scheme. Provided the member died before age 75, the lump sum is usually not subject to UK tax.
The lump sum is tested against the lifetime allowance which considers whether the aggregate benefits taken by the member and the lump sum exceed £1 million (the standard lifetime allowance from 6 April 2016 and this was reduced down from £1.25 m in 2014 ). The liability to the 55 per cent lifetime allowance charge on the excess, if any, rests with the recipient of the lump sum.
Dependant’s scheme pension
A dependant’s scheme pension is usually payable for life (but does not have to be under UK rules), to a person who is a dependant, when the member died.
A dependant includes a spouse, child under 23, child or person who is dependent on the member due to a disability and any other person, who is financially dependent on the member.
A child with no disability can only receive a dependant’s pension whilst they are under age 23, subject to some exceptions.
Small dependant’s pensions may be commuted to a lump sum, provided the lump sum represents the dependant’s entire rights in the scheme and is not more than £18,000 per scheme.
The lump sum is taxed as pension income under UK rules and will fall within the pension taxing provisions in the Double Tax Agreement.
If the member dies after they start their pension, a dependant’s scheme pension may be paid which is based on a proportion (eg, half or two-thirds) of the pension the member was receiving when they died.
Where the pension has a guaranteed term and the member has died within that term, the scheme rules may provide for the dependant’s pension to commence after the end of the term.
A lump sum may be paid, if the member chose to guarantee a set amount of pension and dies before the guaranteed amount of pension is paid.
This ‘pension protection lump sum’ representing the balance of the pension may be paid to any persons or the estate (scheme rules permitting) and is taxed at 55 per cent, for which the scheme is liable.
UK defined contribution schemes
Defined contribution schemes (commonly known as ‘money purchase schemes’) provide retirement benefits based on the amount contributed and the earnings on the investment of those contributions.
The member’s capital in the scheme, or ‘pension pot’, may be used to start a scheme pension or drawdown pension or a combination of the two. According to the UK tax authority (HMRC), many schemes don’t offer drawdown pensions.
A scheme pension has the same minimum requirements as those paid from a defined benefit scheme; that is, it must be payable for life, at least annually, and payments cannot reduce from year to year.
Specific scheme rules will govern the indexation of payments and any guarantees on death.
A scheme pension paid by a defined contribution scheme, however, is likely to be secured by a lifetime annuity purchased either by the scheme or the member.
Drawdown pensions allow the member to choose how much pension they receive each year and are either ‘capped’ or ‘flexible’. Unlike account based pensions in Australia, drawdown pensions have no minimum payment requirement.
A maximum limit applies to the payments from a capped drawdown pension, which is calculated as 120 per cent of the equivalent lifetime annuity that could be purchased with the member’s capital.
Thus a capped drawdown pension operates in a similar way to a lifetime pension as payments are effectively drawn over the member’s lifetime.
No limit applies to payments from a flexible drawdown pension, but to qualify for such a pension the member must be receiving at least £20,000 each year in secure pension income.
Secure pension income consists of guaranteed lifetime pensions such as scheme pensions (including most dependant scheme pensions), lifetime annuities, UK state pension and certain UK social security pensions and benefits.
Equivalent types of pensions paid from an overseas scheme and equivalent social security payments paid in another country also count towards the minimum £20,000 income requirement.
Defined contribution schemes may pay a lump and a dependant’s pension, depending on the whether the member was receiving a pension when they died, and if so, the type of pension they received.
If the member dies and they have not started their pension, a lump sum paid to anyone (scheme rules permitting), is:
Tax free if the member died under age 75, unless the lifetime allowance charge (55 per cent) applies (the lump sum and total benefits taken by the member over their lifetime are tested against the lifetime allowance, which from 6 April 2014 is £1.25 million), or
Taxed at 55 per cent if the member died age 75 or over, the scheme being liable for the tax.
If the member dies after starting a scheme pension, a dependant’s scheme pension and any guaranteed payments within a guaranteed term may be paid. No lump sum is payable from the scheme.
If a member dies after starting a drawdown pension, the following payments may be made:
- Dependant’s drawdown pension;
- Dependant’s scheme pension;
- Lump sum; and
- A charity lump sum benefit, if there is no surviving dependant of the member.
A lump sum may be paid to any person (scheme rules permitting) but is taxed at 55 per cent, for which the scheme is liable.
Australian tax on UK pension benefits
A ‘tax free’ cash lump sum on commencement of a UK pension, is tax free under UK tax rules but is subject to Australian tax provisions applying to lump sums from a foreign superannuation fund.
These provisions include a portion of the lump sum in the individual’s Australian assessable income, if the lump sum is received more than six months after the person becomes an Australian resident for tax purposes.
A resident of Australia for tax purposes (who is not a dual resident) includes pension income from a UK scheme in their Australian assessable income.
A deductible amount may reduce the assessable pension income if the member made contributions to the UK scheme and they did not and were not eligible to claim a tax deduction in Australia for those contributions.
The deductible amount is calculated as the member’s contributions divided by the individual’s life expectancy when the pension commenced.
If the member chose to take a lump sum at the commencement of their UK pension, the member’s contributions must be apportioned between the lump sum and the pension, before calculating the tax deductible amount.
The gross amount of pension income paid from a UK-registered pension scheme is assessed under the social security income test.
Australian income streams generally have a more favourable treatment under the income test as a deduction may apply to the income which is assessed.
The Government’s proposal to apply deeming to account-based pensions from 1 January 2015, will, if passed in its current form, reduce this advantage of an Australian income stream.
A scheme pension paid from a UK defined benefit scheme is exempt from the social security assets test.
A pension from a UK defined contribution scheme, however, is likely to be assessed as having an asset value on the basis that it is ‘purchased’ with the member’s pension pot.
The ongoing asset value may differ depending on the type of pension drawn and should be verified with the Department of Human Services.
Two hot tips
Tip 1: Transfer to a QROPS before the member commences their UK pension
It is highly unlikely that a UK registered pension scheme will allow a transfer of a pension which is in payment, to a QROPS. This is for two reasons.
Firstly, the scheme’s terms and conditions may not allow the transfer in these circumstances and secondly, even if the scheme did allow the transfer, the receiving scheme must provide benefits on a like-for-like basis.
This means the QROPS must continue to pay the relevant type of pension according to UK rules. If these conditions are not met, the member is liable to an unauthorised payments charge, which may be up to 55 per cent.
Tip 2: Quarantine UK benefits in a superannuation fund (QROPS) which is separate from the client’s other superannuation benefits
Two UK rules should be kept in mind in relation to UK benefits within a QROPS:
- Payments from a QROPS are deemed to be made from the member’s UK transferred benefits, before other amounts in the fund.
- UK tax charges apply to ‘unauthorised’ payments from a QROPS, that relate the member’s UK transferred benefits, and the member has either been a UK tax resident in the year of payment or has been a UK tax resident in any of the five UK tax years immediately preceding that year. Unauthorised payments are generally payments which don’t fall within the specific lump sums and pensions allowed under UK rules.
Both rules deter members from accessing their benefits from a QROPS until they satisfy the five-year non-residency rule.
Quarantining UK benefits in a superannuation fund (QROPS) which is separate from the client’s other superannuation benefits may offer the following advantages:
- Within the five-year non-residence period, benefits may be accessed from another superannuation fund, subject to a condition of release being met. Such benefits may not be accessible from the QROPS without triggering UK tax charges.
- Within the five-year non-residence period, any excess non-concessional contributions tax liability may be released from another superannuation fund. The release of such amounts from the QROPS would trigger UK tax charges.
- If the client has a self-managed superannuation fund (SMSF), the transfer of UK benefits to a separate fund (QROPS) may assist the client in avoiding any potential UK ‘taxable property’ charges. Such charges may apply where UK benefits have been transferred to a SMSF registered as a QROPS and the SMSF invests in real property.
A decision to transfer benefits in a UK-registered pension scheme to an Australian QROPS involves comparing the benefits from the UK pension scheme with those available from the Australian superannuation fund.
The nature of the benefits, for example whether they are guaranteed for life or not, and whether any benefits are available on death, will have a significant effect on the client’s final decision.
An obvious advantage of transferring benefits to an Australian QROPS is the opportunity to commence a pension which is tax free from age 60. Australian income streams are favourably taxed. UK are NOT. When a member is receiving a UK drawdown pension dies, a lump sum: is taxed at 55 per cent. In Australia it is taxed at NIL.
Social security may also be a factor in the decision. It’s unlikely that a UK pension scheme will allow a transfer once the member has started their pension, so it’s important to consider the decision to transfer before this occurs.