A comparison of final salary schemes and QROP’S. What should you consider

Below I look at some of the benefits, whilst comparing QROPS to UK Defined Benefit schemes.

A defined benefit scheme, better known as a final salary scheme, is the most generous and secure type of pension arrangement, often referred to as a gold plated pension. The generosity of these schemes has meant most have been forced to close, restrict access or reduce benefits because they are so expensive for the employer to provide and operate.

Transferring out of a DB scheme should always be considered on a case-by-case basis as each scheme will have its own parameters. As a starting point, there are a number of circumstances which warrant the consideration and review of your UK DB scheme:

Passing on as much wealth to your spouse and beneficiaries is a priority for you; 
  You wish to mitigate future income tax liability as much as possible;   You are likely to be in excess of the lifetime allowance by the time you 
retire ( GBP 1 million); 
 You are concerned about future amendments, and possible reductions in benefits  to your final salary scheme; 
 You wish to pass on a lump sum death benefit to a beneficiary of your choosing. 
Maximising a spouses pension

UK pension legislation – In recent years the UK Government have been introducing restrictions on an individual’s ability to shelter tax through the use of pensions. This has been through the reduction in the annual amount that can be contributed to pensions obtaining significant tax reliefs. The annual allowance has seen a fall from £255,000 per annum in 2010/11 to £40,000 in 2014/15.

If you are currently part of a DB scheme, no doubt you will already have seen changes made to your pension, such as a reduction in the growth method or the age at which you are allowed to access your pension. The LTA is another allowance, which has seen a fall in recent years. These factors are clear indicators that the UK Government is trying to limit the tax efficiency of pensions in its bid to deal with the UK deficit.

Testing against the falling lifetime allowance – One of the major reasons for transferring away from a DB scheme is if you are likely to exceed the lifetime allowance. If the LTA is exceeded the excess is taxed at 55% if taken as a lump sum or 25% on withdrawals. This is on top of your marginal rate of tax. This is extremely tax inefficient for pension holders who may exceed the LTA.

When a UK Pension Scheme is transferred to a QROPS its value is tested against the LTA at that point. As the pension has been tested against the LTA at that stage any future growth is then outside of the scope of the LTA; helping you to do away with large additional tax burdens.

Income taxed in country of residence – UK pensions are generally paid out net of basic-rate tax. PAYE applies to all pensions from registered pension schemes. With a QROPS, clients can transfer to a jurisdiction which pays out gross income automatically and charges little or no income tax on their pension benefits so they only pay the tax, if any, applicable in their country of residence.

Pension income tax planning – The income payable from a pension is fully taxable as income and is therefore taxable at a member’s highest marginal rate of between 0-45%. This means that the tax payable can be quite severe. A QROPS has the ability to turn the income withdrawn on and off each year.

A QROPS can provide individuals with the flexibility to draw income whenever they choose which can enable them to be shrewd and protect their pension against the tax-man by maximizing what they draw when in preferable tax jurisdictions. The new ‘Flexi-access’ rules will enable individuals to access their pensions in their entirety or through phased lump sums if they wish.

Note: Only 90% of the pension income from a QROPS is taxable (on a return to the UK)

It is important to note that even if you transfer to a QROPS and return to the UK, pension income paid under a QROPS to a UK resident is classed as a Foreign Pension which is taxable in the UK on 90% of the amount arising, or, as relevant foreign income if the remittance basis is being claimed.

Early retirement from a final salary scheme -A Final Salary Scheme will often have quite punitive early retirement penalties for those who wish to draw their pension prior to the ‘Normal Retirement Age’ set under the scheme.

Typically a scheme may impose a penalty, known as an actuarial reduction, of 0.5% per month. This means if you retire 12 months early the penalty is a 6% reduction in your annual pension income. If you retire 5 years early the penalty increases to 30% of your annual pension.

Scheme deficits and the PPF – The expense of a DB scheme may mean the future ability to provide benefits have been jeopardised. If the pension scheme collapses and the employer becomes insolvent the UK Pension Protection Fund (PPF) may honour the benefits so long as the PPF can itself take on the burden. The PPF is not Government backed and is a levy on other similar pension schemes.

It is important to note that even if the PPF steps in you must be aware that only 90% of your benefit will be protected with a cap of £32,761 per annum. Therefore people with larger pensions are more likely to be impacted by this.

What’s right for you? – Defined Benefit schemes will differ from one scheme to the next and each pension needs to be considered on a case-by-case basis. Taking into consideration your unique set of circumstances and objectives, coupled with a thorough analysis of your UK scheme, will allow you to be able to make an informed decision on the right course of action for you and your nest egg.

IMPORTANT NOTE: This guide aims to provide general information on pensions. It is a short and simplified summary of a complex subject, so please do not make any decisions based solely on the contents of this guide. Whether or not a pension and the investments within it are appropriate to you will depend on many factors, including your individual needs and circumstances. For a personalised recommendation, please contact me.