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While having a pension fund of over £1 million may seem ideal, retirees face a complication. If they contribute over the Lifetime Allowance limit, they face potentially substantial tax bills for the privilege.

These allowances allow HMRC to impose taxes of up to 55% against large pension withdrawals – which could have a dramatic impact on your retirement budget. Expats have several available options to safeguard their life savings from this steep tax bill and minimise exposure. We’ll run through some of those potential strategies here.

Chase Buchanan works with expats worldwide, providing comprehensive financial advice and wealth management support to ensure your financial future is protected. If you are concerned about hitting the Lifetime Allowance and triggering a disastrous tax charge, please get in touch.

Explaining the UK Lifetime Allowance

The Lifetime Allowance (LTA) is fixed at £1,073,100. The government changed this limit in April 2020, and in the 2021 Budget, confirmed it would remain static until at least April 2026.

The LTA sets a ceiling on how much you can save in pension benefits without becoming liable for further taxes, on top of any tax deducted at source from the original contributions. What does that mean for pension savers? In short, it means that if you have a large retirement fund, you could be taxed 25% or even 55% of the value.

Fixing the LTA alongside inheritance tax thresholds can be seen to penalise those who have made good investment decisions. Many more people are impacted than might realise, with lots of individuals having:

  • Multiple pension products, including private and occupational schemes.
  • Employment pension benefits, perhaps without recognising the value.

Given inflation, it is now likely to affect millions of people in the coming years that wouldn’t necessarily consider themselves very wealthy – but will now tip over the limit.

Pension Schemes Included in the LTA Cap

One of the issues with the LTA is that it includes all pension benefits across all products, so simply splitting your retirement assets across different accounts won’t protect your funds from the LTA tax charges.

All pension benefits are included, apart from the UK State Pension, so that means:

  • Defined contribution pension schemes.
  • Private and occupational pension products.
  • Defined benefit plans, calculated at 20 times the annual payments.

Pensions are designed to appreciate, and with accumulated contributions, interest, investment returns and tax relief, it is easier than you might imagine to reach that limit. For example, if you have a defined benefit scheme, based on your final salary from an employer, a pension worth £52,750 a year (or £4,396 a month) will be considered £1,055,000 in value – and therefore, over the LTA.

It is, therefore, crucial to calculate your total pension savings and take action quickly to make sure you aren’t exposed.

Lifetime Allowance Tax Charges

We’ve mentioned the LTA tax rates, but it’s essential to understand when and where they apply.

The tax is payable when you access those pension savings, so a lot depends on whether you are transferring your pension benefits overseas, withdrawing a lump sum, or receiving regular income from your plan.

  • Lump-sum withdrawals over the LTA are taxed at 55%, taken from the funds before the balance is remitted to you.
  • Regular retirement income, including purchasing an annuity, is taxed at 25% on top of any other taxes payable.
  • Pension scheme administrators of defined contribution plans must deduct the 25% tax charge from the pot, leaving you with the remaining 75% to use in retirement.
  • Defined benefit schemes may deduct the tax and reduce your pension payments to recover the amount paid to HMRC.

Living overseas, unfortunately, doesn’t defend your retirement savings from these charges. Given the UK’s double tax agreements with European countries, many international expats are not liable for British taxes on their UK pension income – and pay the local rates.

That can be a compelling reason to consider a permanent move and enjoy minimal income tax deductions or beneficial foreign-source pension tax rates, maximising the value of your pension income. However, if your pension exceeds the LTA, HMRC will take precedence and impose the taxes before payments are made, with no option to claim credits or rebates in any residency position.

Expat Protections from Lifetime Allowance Taxes

Now to the all-important solutions – and ways to safeguard your life savings against losing a quarter, or over half, of your pension fund value.

HMRC assesses your status:

  • When you first begin to access your pension.
  • Every time you draw on your pension after that.
  • Again at age 75.

Therefore, it’s vital to stay on top of the total value should this change. If you pass away, HMRC will test any lump sums paid to your beneficiaries for the LTA and deducted taxes accordingly.

Here are some of the most effective options:

Lifetime Allowance Protection

HMRC does grant protection from the LTA in some specific circumstances. However, the rules are strict, and you need to comply with several conditions to be eligible.

For example, if your fund was worth over £1 million in April 2016, you can apply for Individual Protection 2016 or Fixed Protection 2016. Fixed Protection may apply if you had a scheme of this value in 2016, and haven’t since made any contributions, directly or through your employer.

If you think you may qualify for HMRC protection, please get in touch, as it is crucial to seek professional advice.

Overseas Pension Transfers

Another option for expats is to opt for a pension transfer to a Recognised Overseas Pension Scheme (ROPS).

ROPS funds must be approved by HMRC and can provide a raft of substantial benefits, including:

  • Limited exposure to Lifetime Allowance taxes.
  • Lower pension tax rates.
  • Flexibility over which currencies you save in.
  • Advantages with estate planning and inheritance tax liabilities.

There is an Overseas Transfer Charge to consider, currently levied at 25% on international pensions transferred out of the UK and into a foreign scheme – this applied to all ROPS schemes outside the EU until December 2020 and may now apply to EU scheme transfers.

Pension funds in a ROPS account, once transferred, are not exposed to any LTA taxes, regardless of how much you save or by how much the fund value appreciates.

Alternative Pension Fund Investments

A further alternative is to look at tax-efficient investments outside of pension products. For example, you might opt to withdraw your UK pension benefits in cash and reinvest overseas in your host country. Multiple investment routes may deliver higher returns, greater flexibility, and protection from pension taxes.

You might also look at a Self-Invested Personal Pension (SIPP) scheme, which avoids the Overseas Transfer Charge, and means you can have more control over how you invest your pension.

Again, however, there are tax implications with inheritance planning. The best option for your retirement fund will depend on many factors, including:

  • The current value of your pension funds and projected future value.
  • Where you live, and your plans to relocate abroad.
  • Your retirement expectations, budgets and lifestyle aspirations.
  • Estate planning and exposure to potential inheritance taxes.

It is essential to seek tailored advice before making any decisions about your retirement funds, given the importance of this fund to support you, and your family, into the future.

Please contact Chase Buchanan for further information about any of the potential solutions explored here to craft the most beneficial strategy to protect your pension from LTA taxes.