September 2008

QROPS: whys and wherefores

On 6th April 2006, the commencement of Pensions Simplification regime also brought the introduction of Qualifying Recognised Overseas Pension Schemes (QROPS).

Prior to 6th April 2006, any individual looking to transfer their UK pension fund from the UK to an overseas scheme, had to provide a series of documents to prove that they had ceased living and working in the UK. In addition, they had to give further evidence that they had taken up employment in connection with the receiving overseas scheme and that they were residing in the same country as the scheme.

From 6th April 2006, all the pre April 2006 requirements were removed and the onus shifted from the individual, to provide evidence, to the receiving overseas scheme to register with the UK's Her Majesty's Revenue and Customs (HMRC) and report back to the UK.

The reasoning behind HMRC's decision to change the rules, was to monitor the UK pension funds post transfer overseas and to ensure that scheme members were not cashing in their funds and bringing them back to the UK in the short-term.

In order to become a QROPS and accept UK pensions transfers, an overseas scheme would have to meet the HMRC's criteria for pension schemes set out in 2006/206 Statutory Instrument.

Once QROPS approval was granted, overseas schemes were required to report back any payments, made to scheme members, to HMRC for five complete UK tax years of their residency. The rule changes now mean that potentially, any individual, with a UK pension scheme, can transfer their UK benefits into a QROPS if they wish, regardless of whether they are migrating or not. The qualification requirements, for an overseas transfer, now rest with the scheme rather than the individual.

The first consideration is whether the QROPS can accept the UK pension transfer in the first place. HMRC has, on its website, a list of overseas schemes registered as a QROPS. However, although the schemes listed are registered with HMRC to accept UK transfers - it does not mean that they are willing, or able, to accept transfers in. For example, there are USA 401k schemes that, although listed as QROPS on the revenue website, can not accept UK pension transfers in.

Obligations

Another important consideration is to check as to whether the receiving QROPS is aware of their obligations regarding the UK transfer money received. An overseas scheme has many ongoing responsibilities as to the treatment and payment of the UK pension benefits after they are received. The responsibilities of the overseas scheme are more involved than simply registering with HMRC. If an overseas scheme does not fulfill its ongoing obligations, it may have its QROPS status withdrawn and the member could be subject to tax penalties.

Members of a UK pension scheme, seeking to transfer to an overseas scheme, should take advice from specialists in overseas transfers to ensure the transaction and the schemes ongoing responsibilities are maintained.

A QROPS must ensure, when paying out benefits to members, that the scheme follows the rules of a UK pension scheme for a full five UK tax years of the member's overseas residency. This is known as the reporting period.

If, within the reporting period, a QROPS pays out benefits before the client reaches age 50 - which is increasing to age 55 from 6th April 2010 - an unauthorised payment charge could occur (unless the benefits were paid out in the circumstances of serious ill-health).

In addition, as to when the benefits are paid, how the benefits are paid is also restricted within the reporting period. A QROPS is only permitted to pay benefits in the same format as a UK scheme. For example, income levels from the QROPS can not exceed the maximum under UK annuity or USP (unsecured pension) rules. Therefore, if a member takes their benefits out as a 100% lump sum (because the local rules in the country of the overseas scheme allow this) a tax charge would apply because it is not in keeping with UK rules - and it is taxed as an unauthorised payment. HMRC levies an unauthorised payment charge, of 40% of the payment with an additional surcharge of 15%, totaling 55% tax payable for the member. In addition, the scheme could lose its QROPS status.

There are many advice issues that a UK adviser faces before recommending a QROPS. The local tax rules of the scheme are major considerations. Is there tax on the investments within the scheme? Does the scheme make any tax deductions at source when benefits are paid out?

As the member no longer has to be residing in the same country as the QROPS, the local rules of where the member is tax resident must also be taken into account as a separate issue. What are the income or inheritance tax rules in the member's local jurisdiction? Does the local regime tax individuals on their worldwide investments? Will holding funds in certain QROPS increase the member's liability on these fronts?

IFAs also need to be aware of the permitted investments of the QROPS and ensure that they do not contravene the list of permitted investments set down in the HMRC legislation.

Accrued benefits

UK advisers must also consider any pension benefits a member accrues while abroad. Should the UK pension benefits be transferred across to the member's overseas employer's scheme (providing it is a QROPS)? Are UK adviser's aware that mixing UK benefits and overseas benefits this way leads to the overseas benefits falling under the UK rules? This would clearly have an impact on the member's retirement planning.

In addition, the exchange rate would also have an influence in the decision on when to transfer to a QROPS. Does the QROPS only accept transfers in, providing the funds are converted from sterling to local currency? If this is the case, what exchange rate is applied? Is it a competitive rate? Are the funds being transferred at a time when the pound sterling is strong or weak against the local currency?

Advisers need to ensure that their clients take specialist advice in all of these areas to ensure their UK pension funds are being transferred, to a QROPS, appropriately.

Paul Davies
Client Adviser
Montfort International