PENSIONS, SIPP'S AND QROPS

Qualified regulated specialist advice

DEFINED BENEFIT/ FINAL SALARY SCHEMES

A defined benefit pension is a scheme where the pensionable sum paid to you is set based on a formula that considers how many years you have worked for your employer and the salary that you earned, rather than the value of your investments (Defined contribution scheme).

 

Defined benefit schemes, or final salary schemes as they are most commonly known, pay out a secure income for life, which is revalued each year based on various growth rates. So that once your pension starts to be paid it will increase each year, in order to try and keep inline with inflation. How this is calculated will be dependent on the specific scheme rules. 

They will also commonly pay out a pension to your spouse or civil partner upon death, although this is typically only 50% of the pension value. In some circumstances the employer will pay a children’s pension, although this is very rare.

The pension income you will receive is based on several factors:

 

Your pensionable earnings. This will be measured in one of two ways. This will either be your salary at date of leaving or it will be salary averaged over your career with the employer.

 

The number of years of service, so this would be how long you have worked for your employer.

The accrual rate – This is the proportion of these earnings that you will receive as a pension for each year of membership. The most common accrual rates are 1/6oth or 1/80th of your pensionable earnings. 

Defined benefit schemes usually have a retirement age of 65 and in some cases a retirement age of 60. This is the age when your pension starts to be paid.

In some circumstances you may be able to take your pension earlier (the earliest is 55) but this can reduce your annual pension by a significant amount.

 

As with a defined contribution scheme you can take a pension commencement lump sum, also known as a PCLS. If you take a lump sum this will have an impact on your final pensionable salary. The reduction in the annual salary will be dependent on the schemes specific rules. Up to 25% of any lump sum taken will be free from UK income tax

A Defined benefit scheme is run by a trustee. The onus is on the employer to contribute to the scheme and they are responsible for ensuring that the scheme is funded enough so that it can meet all of its financial obligations and pay each individuals pension or spouses pension in line with the parameters set.

Defined Benefit schemes are on the decline and many companies have either closed such schemes to new members or closed them completely and instead now operate a defined contribution scheme.

The main reason for this is that companies are struggling to fulfill their obligations and a huge amount of schemes are in deficit. This means that some individuals may run the risk of not receiving the pension that they thought they were entitled to, or that the scheme may change it’s rules.

Examples of this could be increasing the normal retirement date or a movement in revaluation from RPI to CPI. Because of this final salary schemes are no longer seen as the gold plated pension schemes they once were.

How do they work and what's the difference?

SIPP'S AND QROP'S

THE UK BASIC STATE PENSION

How much are you entitled to?

The new state pension will be a regular payment from the government that you can claim if you reach retirement after the 6th April 2016. In order to receive the new state pension you will need to be deemed as eligible and satisfy certain criteria.

The new full State Pension will be no less than £151.25 per week. Your national insurance record is used to calculate how much of the state pension you are entitled to. You’ll usually need a minimum of 10 qualifying years to get any new State Pension and you will need a full 35 years worth of NI contributions in order to receive the full state pension.

As a British expatriate and according to current legislation you are still able to benefit from inflationary increases in the UK state pension, providing you retire within a certain jurisdiction. This is inline with the triple lock so that your basic state pension will increase with the higher of national average earnings, CPI or 2.5%. You can find out how much you are entitled to by completing a BR19 form or visiting the government website. 

DEFINED CONTRIBUTIONS SCHEMES

Also known as money purchase arrangements

A defined contribution, or money purchase, pension scheme is a type of workplace pension. Money purchase schemes cover a wide range of different pension plans. Some are provided by employers and others are individual schemes. It is built up through your own contributions, those of your employer and tax relief from the government (if you are resident in the UK)

Types of defined contribution pension include:

  • Executive pension plan

  • Group personal pension

  • Master trust pension (eg NEST, NOW pension, the People’s Pension)

  • SIPP (Self Invested Personal Pension)

  • SSAS (Small Self Administered Schemes)

  • Stakeholder pension

 

Defined contribution schemes will provide you with an accumulated sum when you come to retire. You can use this capital sum to secure a pension income through buying an annuity or opting for income drawdown. Since April 2015 the new full flexibility rules apply, which mean you can now access your funds in whatever manner you wish, taking as much or as little as you like. 

Money purchase schemes provide benefits on retirement based on the amount of money that has been paid in to the scheme, how long this money has been invested, the level of charges and investment returns over this period.

DC schemes also provide more flexibility for the member regarding their investment choices. Some members may prefer a cautious, safe approach with low risk but lower potential return, whilst others may prefer a higher risk strategy for a higher potential yield. 

SIPP'S

A Self-Invested Personal Pension (SIPP) is the name given to the type of personal pension scheme, which allows individuals to make their own investment decisions from the full range of investments approved by HMRC.

Traditional personal pensions limit your investment choice to a shorter list of funds normally run by the pension company's own fund managers. With a SIPP you can invest almost anywhere you like and choose your own investments. The HMRC rules allow for a greater range of investments to be held than Personal Pension Plans, notably equities and property.

There are however some limits and you cannot hold assts such as fine wine, art or residential property within a SIPP.

For many individuals who have a number of frozen UK pensions (whether DB or DC schemes) this is a great way of taking control of them and allowing for consolidation of your funds. 

Unlike most DB schemes you can access your SIPP at the age of 55. A SIPP will still qualify for your 25% tax- free lump sum. You can then decide whether to take the rest as an income or take advantage of the new pension freedoms that came into effect in April 2015, which will now allow you to take as much of your pension as you wish.

QROPS

QROP's -A Qualifying Recognised Overseas Pension Scheme, or a QROPS, is an overseas pension scheme that meets certain requirements set by HMRC.

The QROPS program was launched on 6 April 2006 as a direct result of EU human rights legislation with regards to freedom of capital movement. 

QROPS are increasingly popular with British Expats due to currency and investment flexibility, the tax advantages they offer when drawing pension benefits and their ability to be transferred to beneficiaries of choice in the event of death. 

Pension funds left in the UK are taxed on income at up to 45% and taxed on death after 75 years old at up to 45%. Transferring a UK pension fund into a QROPS can (in some cases) reduce taxation and avoid UK taxation as long as the pensioner remains tax resident outside the UK. This is dependent on the jurisdiction of your QROPS and Double Taxation Treaties in place.

A QROPS can be appropriate for UK citizens who have left the UK to emigrate permanently and intend to retire abroad having built up a UK pension fund. Alternatively, a person who is born outside the UK having built up benefits in an HMRC-approved UK pension scheme can move their pension offshore if they want to retire outside the UK. An individual who is also likely to exceed the lifetime allowance could benefit from a transfer into a QROPS.

It is important to note the recent changes to legislation and QROP's mean that it is in most cases no longer suitable for those looking to transfer to a QROP'S outside of the EU whereby HMRC will charge a punitive 25% tax of the fund value upon transfer. Exceptions will apply to the charge allowing transfers to be made tax-free where people have a genuine need to transfer their pension, including when the individual and the pension are both located within the European Economic Area.

THE LIFETIME ALLOWANCE

Know your limits

We have previously seen the lifetime allowance fall from 1.8 million, down to 1.5 million and  yet again from £1.25 million to £1 million from 6 April 2016. 

 

Since April 2018, the lifetime allowance has been set at £1,030,000 and it will increase in line with inflation at the end of the current tax year. While most people aren’t affected by the lifetime allowance, you should take action if the value of your pension benefits is approaching, or above, the lifetime allowance.

Savers will pay tax on any excess savings above the Lifetime Allowance Limit.

The rate of tax depends on how savers receive the excess. If it is in the form of a lump sum, then the rate of tax is an eye-watering 55 percent. If it is in the form of a regular pension, the excess is taxed at 25 percent. This is on top of your marginal rate of tax. 

There are various mechanisms of protection you can apply for dependent on your circumstances, such as Fixed Protection, Individual Protection or you may apply to HMR for an enhancement on your LTA if you were an active member of a  UK scheme while living abroad. You can find out more about applying for an Enhancement Factor here .

A pension transfer specialist can help you apply for the most appropriate form of protection and an increase in your LTA if you are likely to exceed the limit,