QROPS And The Impact Of The Lifetime Allowance

One of the problems with pension planning is predicting how the government is likely to tinker with your retirement savings in the future.

No one would have expected the latest consultation document looking to change the underlying rules of the steel workers’ retirement scheme aimed at making Tata Steel more attractive to a buyer.

Chancellor George Osborne and his predecessors have also reformed pensions drastically in the past decade.

For expats looking to transfer their UK retirement savings to a Qualifying Recognised Overseas Pension Scheme (QROPS) this tinkering presents some problems.

When transferred to a QROPS, the expat’s total pension savings are tested against the lifetime allowance (LTA).

How the QROPS LTA test works

The test is designed to check whether the pension fund exceeds the lifetime allowance so HM Revenue and Customs (HMRC) can tax the excess.

Any amount that is over the LTA for the year is taxed at 25%.

In recent years, the LTA has yo-yoed between £1.5 million and the current level of £1 million (2016-17).

From now on, Chancellor George Osborne has ruled the LTA will increase in line with inflation each year – but his policy is not binding on future incumbents in his office.

As inflation is running at around 1%, the LTA is only likely to change by around £10,000 a year.

LTA is a cap on pension income

The Bank of England inflation target is between 2% and 3% – which gives an annual increase of around £25,000.

The LTA is important because any retirement saver with a UK pension fund of less than £1 million who expects to breach the amount can switch the fund into a QROPS without penalty.

If and when the fund then smashes through the £1 million glass ceiling, because the money is in a QROPS, the LTA does not apply.

The LTA effectively caps a UK pension at the likely investment return on £1 million – generally considered around 3% a year. This equates to a tax-free lump sum of £250,000 and a yearly income of £22,500 generated by the remaining £750,000.

QROPS retirement savers can neatly sidestep this cap by removing the LTA limits on their pension.