Tax Free Double's Just Toil & Trouble

A newly identified loophole has surfaced in the new Lifetime Allowance legislation and it was doing the rounds in the financial press this weekend.

The reports are of being able to double the amount of tax free cash available from pensions to £536,550.

The reality is not so straightforward. 

---

I’ve read various articles with various scenarios which purport to show working examples of how many “savvy pensioners” can increase their tax free cash to £536,550.

I struggled to follow the logic of many of them and some are so fantastical that there may only be one individual who could possibly find themselves in this mythical situation of going on to build double pension pots.

These stories are click bait. And they work. See, here you are.

Does The Loophole Exist?

All fine in theory, but does it work for anyone in practice? The short answer appears to be yes, however.

First off, I can’t see this loophole surviving.

Second, it will mostly to be of interest to those with benefits above the lifetime allowance and are yet to crystallise some or all of their benefits.

Third, it involves transferring some or all of your pension to a Qualifying Recognised Overseas Pension Schemes (QROPS).

If that hasn't put you off, read on.

Understanding the Mechanism Behind the Loophole

So, how exactly does this loophole function?

At present, when you transfer your pension to a QROPS (Qualifying Recognised Overseas Pension Scheme), it's treated as a Benefit Crystallisation Event in relation to the Lifetime Allowance (LTA). This essentially means that at the time of the transfer, the value of your pension is assessed, and any amount that exceeds the LTA would typically be subject to tax.

However, under the current rules, there's no tax charge applied to these transfers, meaning that moving your pension to a QROPS doesn't trigger any additional tax in relation to the LTA.

The upcoming changes in the legislation introduce several new limits, among which the Overseas Transfer Allowance (OTA) is particularly pertinent to this discussion. Starting from April 6, the total amount you can transfer to a QROPS will be capped by the OTA. Any amount over this limit will incur a 25% tax charge.

It's crucial to note that the OTA won't be enforced until April 6, leaving a window where there's effectively no cap on the amount you can transfer to a QROPS without attracting the 25% tax charge.

Let's clarify this with an example to better illustrate the point.

Worked Example

James has two separate pension pots: one is a Flexi-Access Drawdown and the other is a Personal Pension with a value of £1 million.

A few years back, James activated his Flexi-Access Drawdown by crystallising £1.25 million from his pensions, which effectively utilised 100% of his Lifetime Allowance (LTA). Rather than withdrawing the amount that exceeded his LTA and facing a 55% tax charge, he chose to keep this excess, the current £1 million, in a Personal Pension, intending it for his children's inheritance.

With the current window of opportunity before the 6th of April, James has the option to transfer this £1 million personal pension into a QROPS. At the point of transfer, this amount would undergo a Benefit Crystallisation Event (BCE) check. Although this transfer exceeds the LTA, the tax charge, under the current transitional rules, would be zero.

Following this transfer, James's retirement savings are now split between his original Flexi-Access Drawdown and the newly established QROPS. When it comes time to access his QROPS, James can withdraw a portion as tax-free cash, according to the specific rules of the QROPS. Most QROPS follow the UK's guideline, allowing for a 25% tax-free cash withdrawal - though some, like those in Malta, offer up to 30%.

This could net James £250,000 or even more in tax-free cash.

Conversely, if James had opted to keep his Personal Pension within the UK, any subsequent withdrawals would be taxable as income, since he's already taken the maximum tax-free cash from via Flexi-Access Drawdown plan.

Potential Pitfalls

Navigating the opportunity that QROPS and the related legislative changes present comes with its set of complexities and considerations.

One primary concern for individuals considering this route is the increased scrutiny from HMRC. Engaging in QROPS transfers makes these transactions visible to tax authorities, (QROPs transfers are reported to HMRC from providers) placing individuals more prominently on HMRC's monitoring scope. This is particularly relevant as QROPS are generally only intended for those relocating abroad.

While it might seem viable to initiate a QROPS transfer after April 6th, given the Finance Bill's structuring of the overseas transfer allowance as distinct from other allowances, there's a strategic advantage to acting sooner rather than later. Delaying the transfer gives HMRC additional time to identify and potentially close this loophole, increasing the risk for individuals looking to benefit from it. However April is just around the corner and the chances of turning around a transfer in that time are slim to none.

Additionally, there's the risk of HMRC applying changes retrospectively, especially if they perceive the transactions as purely tax avoidance strategies. Such actions could fall under the scrutiny of General Anti Abuse Rules (GAAR), leading to potential complications and liabilities.

Beyond the regulatory landscape, the financial implications of opting for a QROPS must be carefully weighed. The costs associated with QROPS can be significantly higher than domestic pensions, and choosing the right jurisdiction for the transfer involves navigating a complex web of international tax laws and treaty agreements.

These factors make it essential to undertake thorough due diligence and seek professional advice before proceeding with such a strategy.