This article deals with pensions for new and returning residents (olim) from the UK.
The UK-Israel Tax Treaty allows Israeli residents an exemption from UK tax on UK pensions, provided the pension is subject to UK tax. But if Israel grants a 10-year exemption to olim, the UK can tax the pension.
However, thanks to recent changes in UK-Israeli pension rules and Israeli tax rules, there is now the opportunity for olim to avoid paying income tax on their pensions for 10 years. In addition, up to 82 percent of UK tax can be avoided on death.
In 2006, Her Majesty‘s Revenue and Customs ( HMRC) introduced a radical shake-up of the UK pension system. It was called ‘‘pension simplification,‘‘ but the result is far from simple. As part of this process, HMRC introduced QROPS (Qualifying Recognized Overseas Pension Schemes). This in essence allows nonresidents to export their pensions out of the UK.
Because of the way the tax system works, one of the greatest beneficiaries of these new rules are individuals who have moved ( or are moving) to Israel.
Under existing UK rules, a pension works in the following way: from age 50 (next year from age 55) non-state pension benefits can be taken. Most pensions have the ability to take 25% out as a tax-free lump sum, although some pensions allow more than this. The remainder of the fund is used to provide an income that can be generated in either of two ways.
The first way is the traditional annuity where a pension
YOUR TAXES ‘‘pot‘‘ is handed over to an insurance company in return for an income for life. In its simplest form this means that when the person dies so does the income.
The second way is ‘‘income drawdown.‘‘ Here one can draw an income from the fund but still keep control of the ‘‘pot.‘‘ This is known as USP (Unsecured Secured Pension). This can continue until age 75, at which point an annuity must be taken or the pension must go into ASP (Alternatively Secured Pension).
ASP is broadly similar to USP, although the amount of ‘‘income‘‘ that can be taken is less than is allowed in USP. People started to use this as a method of passing on pensions free of tax on death. HMRC has since tightened the rules on ASP; now, if a person were to die after age 75 having already used their nil rate Inheritance Tax band, the tax and penalty charges combined would result in a charge of up to 82% of the pension pot.
This comprises an unauthorized payment charge of 40%, an unauthorized surcharge of 15% and a scheme sanction charge of 15%, with inheritance tax of 40% still applicable depending on the individual‘s circumstances. (There could also be a scheme de-registration charge of 40%.) Prior to age 75 (ASP) there is a 35% tax charge on death.
However, around the same time as introducing the new tighter UK rules, HMRC also introduced QROPS, which allows people who have moved offshore to take their pension offshore.
There are a number of worldwide jurisdictions that you can move your pension to. Each jurisdiction has its own pension taxation rules, with some being more favourable than others. One example is Guernsey, a stable Crown-dependent offshore center. Guernsey does not charge any tax on pensions if the individual does not live there. Thus a person living in Israel with a pension in Guernsey would not be subject to Guernsey tax. Provided they are nonresident in the UK, they should not be subject to UK tax either. That leaves Israeli tax to consider.
If you are a new immigrant, you benefit from a five-to 10year tax holiday (depending upon when you moved), so you may not need to pay Israeli tax for up to 10 years on your pension income.
Additionally, and perhaps more importantly, there is no requirement to purchase an annuity; after you die, you can pass the entire pension pot to your spouse and/or children free of any tax. Guernsey will not tax you or the pension fund. If you are resident in Israel and the pension is no longer a UK asset (because it has been moved to Guernsey), HMRC will not tax it either (provided you are no longer UK domiciled). Israel does not have inheritance tax, therefore there will be no tax to pay in Israel. Thus you can pass on your pension free of any tax.
This is an opportunity for anyone with private or corporate pensions from the UK, including SIPPs (Self Invested Personal Pension) and SSAS (Small Self Administered Scheme).
QROPS also offer investment flexibility. For example, once you have been out of the UK for more than five complete tax years, you could consider purchasing residential property with your pension funds.
QROPS had a rocky start since it was launched in 2006. One scheme in Singapore was closed by HMRC for apparently bending the UK tax rules.
Additionally, some of the trust companies that have created a QROPS are small companies run by a few individuals. However, the rules have now settled down. Guernsey, in particular, negotiated with HMRC and refined their pension rules to accommodate HMRC‘s concerns. There is now at least one major international financial institution that provides an ‘‘Overseas Pension,‘‘ which claims to be HMRC compliant at reasonable cost via Guernsey.
In view of these changes, anyone from the UK should review their pension arrangements in good time. Sadly, if you have already purchased an annuity, it is too late and nothing can be done. There is also nothing that can be done with UK state pensions.
Pension arrangements, especially overseas arrangements, are complicated and you will need advice from experienced pension consultants. Please e-mail the undersigned if you want further details.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is an international tax specialist.