UK Emergency Budget and the implications for British expats

Thursday 29 July 2010

Following announcements from last week Close International comments further on the 2010 UK Emergency Budget and the implications for British expats.

Whilst living outside of the UK, typically in the sun, British Expats should not overlook the importance of the UK Budget as such things can have far reaching effects even for UK non residents. In this respect the UK’s 2010’s emergency budget is no different and brings with it good, not so good and ambivalent news.

The main extracts to take note of:

- Qualifying Recognised Overseas Pension Schemes (QROPS)
- Deferral of annuitisation
- IHT protection
- Indexation changes from RPI to CPI
- Frozen pensions benefit for key Commonwealth countries

QROPS

Much speculation of changes to the QROPS rules did not materialise leaving QROPS as a credible and legal route for transferring a UK pension to an overseas pension without generating any negative tax charges.

The advantages to expats are many and include, no restriction on pension contributions; the ability to mitigate currency risks or generate pension income in the currency of their new country of residence; no UK IHT on the accumulated retirement fund; no requirement to purchase an annuity; and of course the ability to pass any of the unused pension assets (on death) to a wide range of beneficiaries from individuals to trusts.

However advisors and clients should take care when selecting a provider as the actions of many QROPS providers have been brought into question. Payments or actions outside of the strict requirements for QROPS can lead to scheme disqualification, frozen scheme assets and high tax charges; costs associated with QROPS should also be considered.

Deferral of Annuity

The first glimmer of improved flexibility for pensioners has manifested itself in the budget, as members of UK registered pension schemes will no longer need to purchase an annuity at the age 75.

These changes came into force from the 22 June 2010 and will affect many British expats; particularly those who are currently taking income drawdown or those who have not yet opted to take pension benefit.

The Budget’s interim measure enables members of registered pension schemes, who reach the age of 75 (on or after the 22 June 2010) not to have to buy an annuity or otherwise secure a alternative pension income until after they reach 77.

What takes the shine off this announcement is that it currently only allows a two year deferral of the need to purchase an annuity or opt for the alternatively secured pension route. That said, the two years will allow many pensioners breathing space to plan their next move.

The full rules are expected in early 2011, following an extensive consultation process, but this could be the first real step towards providing additional flexibility during retirement.

Inheritance Tax Protection

Importantly, this interim measure mentioned above, provides a degree of IHT protection where a secured or scheme pension has not been obtained post their 75th birthday. Hence qualifying pensioners will see a total tax charge of 35% as opposed to maximum tax charge of 82%, should they pass away between the age of 75 and 77.

Unfortunately, those pensioners who were already over the age of 75 as at 22 June 2010 and have not secured a pension income can still be subject to combined IHT and tax charges of to up to 82% on death.

Hence a transfer to a QROPS remains a very strong consideration, as these schemes are not subject to UK IHT, special lump sum death benefit charges or unauthorised payment charges when distributing their assets on the death of the member. However, expats must consider carefully wealth or inheritance taxes that may apply to distributions in the countries where they reside.

Revision of State Benefit Age

The revision of the UK State pension benefit age to 66 by possibly as early as 2016 must also be factored into the financial plans of all those considering to retire abroad. And with the reality of this being pushed out to 70 years of age in the following decade asks significant questions as to how individuals who wish to retire earlier are to fund their retirement.

RPI to CPI

The link between the annual increase of the UK state pension and the Retail Price Index (RPI), which was established in the 1995 Pensions Act, has been amended to the Consumer Price Index (CPI).

CPI is the standard measures of inflation on internationally agreed standards throughout Europe. The main point of difference is that RPI includes mortgage interest payments.

Thus changes in the interest rates effects RPI and not CPI. Hence, a cut in interest rates typically results in a fall in RPI inflations and visa versa. The controversial aspect of this move is that historically RPI has typically exceeded CPI. This means that pensioners have been financially better off over the past 10 years because of RPI being higher than CPI. Currently RPI stands at 5% where as CPI is 3.2%. Over a 10 to 15 year period a difference in compound returns of 1% to 2% percentage point per annum can make a considerable difference to earnings. Hence this amendment to the measure of inflation and indexation will likely leave all pensioners with lower annual increases in their state pension benefit.

No Move on Indexation for Commonwealth Countries

Lastly, the budget was unsurprisingly silent on the inequality of indexation of state pension benefit for those Brits that live in South Africa, Canada, Australia and New Zealand. Whist British expats in the EEA, USA and certain other countries benefit from inflationary annual increases, others do not, irrespective of the level or duration of contribution to the social security system in the UK.

Given the latest rulings on this matter any change to the position, which affects around 600,000 Expat Brits, will take time and conviction.

Summary

Rex Cowley, Head of Marketing at Close International said:

‘The budget could have been a lot worse for all, but what is clear is that pension provision and social security are front and centre of the agenda. QROPS remains a real option for those looking to pass on wealth, who don’t want to commit to an annuity, or those who are looking to shake off their UK domicile. For those British Expats that favour keeping their pension in the UK, they will most likely see more flexibility after their 75th birthday and more favourable protections from IHT during the interim period up to age 77 where pension benefits are not already secured. As for indexation, most British Expats are in the same boat and can expect the new inflation index to result in smaller annual increases to their pensions. For those living in the key commonwealth countries, unfortunately it’s another year on inequitable treatment as state pension benefit remains fixed at the point in time at which they left the UK’.