A SIPP is a pension ‘wrapper’ that holds investments until you retire and begin to draw an income. It works in a similar way to a standard personal pension. The main difference is that with a SIPP you typically have more flexibility when you choose what to invest into.
With standard personal pension schemes, your investments are managed for you within the pooled fund you have chosen. SIPPs give you the freedom to choose and manage your own investments. However, because this is a complex area, most people choose to have an authorised investment manager make the decisions for them.
ESSENTIAL DETAILS OF A SIPP
A SIPP is based in the UK and regardless of where you live it is regulated by UK law.
A SIPP is available to you regardless of where you live in the world.
Under current legislation you can start drawing retirement benefits from the age of 55. You can do this even if you are still in employment.
Your benefits are flexible. You may draw as much or as little income as you like. You can also stop and start withdrawing whenever you wish.
Up to 25% of your total funds can be withdrawn as a tax-free cash lump sum.
If needed you can transfer your funds into a QROPS later on.
SIPPs are excellent for those who plan to retire in the UK. They are equally beneficial for those in a nation with a preferential double-taxation agreement with the UK.
SIPP investments grow free of capital gains tax or income taxes.
WHAT CAN YOU INVEST INTO WITHIN YOUR SIPP?
Quoted UK and overseas stocks and shares
Collective investments (such as OEICs & unit trusts)
Exchange traded funds (ETFs)
Property & land (but not most residential property)
Some SIPPs can also raise a mortgage against property. The rent will go towards paying down the loan and the costs of running the property.
THINGS TO CONSIDER ABOUT SIPPS FOR EXPATS
A SIPP is a personal pension. You are not required to live in the UK to be able to invest in one. However, there are important considerations if you do not live in the UK and are thinking about using a SIPP:
Even though a SIPP is held in the UK, it is possible to have a multi-currency SIPP. This can be a great benefit to expats as it helps to mitigate currency fluctuations on both contributions and withdrawals.
SIPPs abide by UK pension rules and as such are affected by any changes the UK Government makes to pension rules. A recent example of this would be the changes to the Lifetime Pension Allowance that saw a reduction in the allowance from £1.25m to £1m.
When drawing an income from your SIPP you will still be subject to UK income tax. If you no longer live in the UK, your income may also be subject to tax in your country of residence. Hence it is critical to understand the local tax rules as well as those in the UK. You can then make an informed choice about how to draw an income from your SIPP.
Many expats will speak to a financial adviser while making a decision about their retirement plans. They will do this because it is a very complex and critical area. If you are seeking advice from an adviser in the UK, remember that they may not be fully aware of all the opportunities for expats.
WHAT IS A QROPS (QUALIFYING RECOGNISED OVERSEAS PENSION SCHEME)
A QROPS is an overseas pension scheme that meets certain requirements set by HMRC.
A QROPS must have a beneficial owner and trustees, and it can receive transfers of UK Pension Benefits. QROPS came about as part of UK legislation launched on 6 April 2006. This was a direct result of EU human rights directive for the freedom of movement of capital and labour. It is essentially a trust or a contract-based offshore pension. As such the tax residence of the beneficial owner or beneficiaries is critical, as some countries do not recognise trusts.
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 a UK-registered pension scheme can move their pension offshore if they want to retire outside the UK. Unfortunately, your UK State Pension benefits cannot be transferred. Defined contribution, defined benefit pension schemes and SSAS pensions can be transferred abroad though.
A QROPS does not have to be established in the country where one retires; rather, a person can move the pension to another jurisdiction and have the benefits paid into their country of choice. Moving to a QROPS could also be a good option for expats who are intending to return home but are approaching the lifetime allowance or have already gone over the lifetime allowance.
QROPS KEY POINTS
As with other private pensions, you can begin drawdown from the age of 55
With a QROPS access is flexible meaning you can draw down as much or as little as you like.
QROPS typically offer a broader range of investment options and are not subject to the same restrictions most UK pensions are.
In contrast, unlike defined benefit pensions, which typically only have a limited inheritance amount for spouses, a QROPS allows you to name any chosen beneficiary you like.
QROPS allow you to hold and invest in multiple currencies. This can make them appealing to expats who will be retiring abroad and don’t want to be receiving their pension in pounds sterling.
The benefits of a QROPS can vary depending on how long you have been offshore, intend to stay offshore and whether you remain offshore for a long or short period of time.
A QROPS can allow you to take an enhanced tax-free lump sum when you begin drawdown. This increases to 30% from 25%.
Much like a SIPP, a QROPS can be used to consolidate multiple pensions.
If you transfer into a QROPS and you live outside the EEA (European Economic Area) you will be subject to the ‘Overseas transfer charge’ – which is 25% of the value.
WHAT IS A DEFINED BENEFIT (DB) PENSION?
In the United Kingdom, Defined Benefit pensions, sometimes called Final Salary schemes, are a type of workplace pension that will pay a promised income in retirement. The income level paid to you is calculated based on your salary at the point of departure (hence the term ‘Final Salary’) and the total number of years of employment with the company or organisation in question.
Unlike defined contribution schemes, there is not an accumulated amount of money that is built up over time through continual contributions – simply an income promise that the employers’ scheme administrators then must ensure that they can fulfil.
It is the employer’s responsibility to make sure that sufficient funding is available within the scheme to pay and its other members the promised income when you reach retirement.
These days, Defined Benefit schemes are quite rare but were immensely popular among large employers up until the turn of the millennium. They are also commonly used across the public sector.
DEFINED BENEFIT VS. DEFINED CONTRIBUTION PENSIONS
The value of a Defined Contribution pension when you reach retirement completely depends on how much you have paid in and how well your investments have performed, much like any type of personal investment account.
In contrast, a Defined Benefit pension promises an income in retirement rather than a pot of money and this is calculated based on several factors, the first of which is the length of time you worked for the company.
The company will use the salary that you were earning whilst working for the company (most commonly this will be your final salary, but some schemes will use an average of your salary over your entire period of employment) and factor that into the calculations. There is also something called the accrual rate, which is the proportion of your salary (be it average or final) that you will get as an annual retirement income.
UNDERSTANDING DEFINED BENEFIT SCHEMES
A key point to understand with Defined Benefit schemes is that your employer is responsible for making sure that the scheme is sufficiently funded to fulfil the retirement income obligations that it is promising to you and its other members. If the company gets into financial difficulty and cannot fulfil that income promise then the Pension Protection Fund (PPF) in the UK can step in and cover your pension income, but the outcome here will normally be that you receive a lower amount than you were promised by your employer.
Whilst a Defined Benefit scheme does not hold a live cash value in the same way as a Defined Contribution scheme does, a member can request a ‘Cash Equivalent Transfer Value’ to be calculated by the scheme if they wish to exit the DB arrangement and convert the benefits into a Defined Contribution type scheme or personally managed pension.
TRANSFERRING DEFINED BENEFIT PENSIONS
Deciding to transfer out of a Defined Benefit pension is not something that should be done without professional advice and analysis. There is a lot to understand and required procedures to complete before committing to an authorised transfer of what may well be an incredibly significant sum of money.
One of the first steps that will need to be taken will be to make a request to the existing scheme to calculate the CETV (Cash Equivalent Transfer Value). This will effectively be a settlement offer from the scheme to convert your promised benefits into a cash value and make this available to you as an alternative to retaining the promised benefits of the DB scheme. Some companies will be keener than others to encourage members to transfer out of their scheme – and this will play a part in dictating how ‘generous’ the cash offer is and how the calculation is made. Companies that have concerns about the scale of their long-term income commitment to members may elect to try and encourage members to transfer out to reduce their liability.
WHEN CAN YOU TRANSFER OUT?
Defined Benefit pension transfers into Defined Contribution or personal pension plans can provide valuable financial planning opportunities in the right circumstances. Flexible access drawdown allows benefits to be taken earlier than most Defined Benefit schemes do, and many people will use this facility to withdraw their 25% tax-free lump sum (if they are at least 55 years old) and leave the remainder of their pension fund invested for use for income later.
For members who have settled outside of the UK as long-term expatriates, Defined Benefit pension transfers have additional factors which need to be considered and can make this a more logical action if there is a strong possibility that they will retire overseas.
It is essential to take advice from an authorised Pension Transfer Specialist (PTS) with respect to DB transfers and as a member, it is imperative to make sure you understand:
The promised benefits that you will be giving up
How the transfer will fit in with your overall retirement planning
How your retirement income expectations will be achieved and how this projection compares to the income that the DB scheme was promising you – this is a key part of analysis that the PTS is required to work through with you.
LIFETIME ALLOWANCE AND DB PENSIONS
The Lifetime Allowance (LTA) limit in the UK is a key factor to be considered too for members with larger CETVs calculated. Currently, the LTA limit is 1,073,100 GBP (Great Britain Pound) and this means that any pension (DB or DC (Defined Contribution)) that exceeds this amount in value will create a tax liability of between 25% and 55% on the amount over and above the LTA limit. Protection can be applied for up to 1,250,000 GBP but is not available to everyone.
For non-UK residents (expatriates) the LTA can be avoided for life if they transfer their benefits into an overseas scheme such as a QROPS (Qualifying Regulated Overseas Pension Scheme) – depending on where they are now residing there may be an overseas transfer charge applied, which will also need to be factored into the transfer analysis by your Pension Transfer Specialist.
WITHDRAWING MONEY FROM YOUR DEFINED BENEFIT PENSION
A Defined Benefit pension pays you an income in retirement and your pension income increases each year to consider the rising cost of living.
You can take the option of withdrawing 25% of your pension as a calculated tax-free lump sum when you reach 55. If you choose to do this the pension administrators will reduce the retirement income that you are being promised to reflect how much you have withdrawn from your pension as a lump sum.
When you die, typically a percentage of your pension can be paid to your surviving partner or dependents.
WHAT IS A DEFINED CONTRIBUTION (DC) PENSION?
In the United Kingdom, Defined Contribution pensions, sometimes called Money Purchase schemes, are now the most common type of pension. When you retire, the value of a defined contribution pension will simply be determined by how much money you and/or your employer have paid into the pension, how the investment of those funds has performed, and how much tax relief you have received.
While defined benefit pension schemes usually pay you a retirement income based on your salary while you were working, a defined contribution pension works more simply and can be looked upon as a similar asset to a tax-friendly savings account.
You and/or your employer can both pay money into your pension. Your pension provider will claim tax relief on your behalf and add it to your pension. Your pension provider usually makes the investment decisions and places the money in asset classes such as shares, property, bonds, and cash.
DEFINED CONTRIBUTION VS. DEFINED BENEFIT PENSIONS
Defined Benefit schemes promise an income in retirement – a promise made by your employer. Defined Contribution schemes do not promise an income – what you get in retirement will be determined by the value of your pot when you retire. That pot will provide you with an income but there is no guarantee of what that will be.
Defined Benefit schemes tend to be run on a collective basis, whereas Defined Contribution schemes are individual products. This means that Defined Benefit schemes are based around a theoretical average member, with average life expectancy, and average pay rises. Someone who lives a long time and who leaves a dependent who receives a pension may, personally benefit more than someone who will not live as long and who has no surviving dependents. Some people will fare better than others out of this collective model.
DEFINED CONTRIBUTION SCHEMES AND INVESTING
A vast area of risk is the return on investments. In a Defined Contribution scheme, if your investments perform very well then you should be on track for a better retirement whereas poor investment performance means that you, as a member, lose out. In a Defined Benefit scheme, poor investment performance means that a sponsoring employer must find more money to meet their promise.
Similarly with life expectancy – if people are living longer, then a Defined Contribution member will have to make their savings last longer, whereas a Defined Benefit scheme member will not see their pension changed, but the sponsoring employer would have to find extra money to pay the pension for longer.
There is no way of knowing if someone would be better or worse off under a Defined Benefit or Defined Contribution scheme – a good Quality Defined Contribution scheme could give a much better outcome than a poor-quality Defined Benefit scheme.
TRANSFERRING DEFINED CONTRIBUTION PENSION
Transferring a defined contribution pension transfer involves moving your pension from one place to another. This might be as simple as switching pension funds with the same provider, to achieve a better investment risk balance, or moving your pension pot to an entirely new provider for similar reasons.
CONSOLIDATING MULTIPLE SCHEMES
Consolidation of multiple pensions is another common reason for transferring – it has become incredibly common to have multiple pension pots, especially since auto-enrolment came into effect in the UK where everyone who qualifies is automatically enrolled into a workplace pension scheme.
Consolidating multiple schemes can:
Reduce Costs if you are currently paying several sets of fees across multiple schemes
Simplify the task of keeping track of your retirement investments and their performance
Make it easier to estimate your projected retirement income and estimate any existing shortfall
Provide simpler visibility of where you stand versus any pension limits such as Lifetime Allowance.
HOW TO TRANSFER
To transfer your defined contribution pensions, you (or us on your behalf as your adviser) will need to contact your current pension provider, check that the scheme will allow a ‘transfer out’ and request an up-to-date valuation. You can request and obtain a current valuation at any time.
Once you/we have this information, we can then set about the task of identifying an appropriate destination for the transfer and ensuring that your retirement assets moving forward are being held, invested, and managed in the most appropriate type of pension for you.
WITHDRAWING MONEY FROM YOUR DEFINED CONTRIBUTION PENSION
When you come to retire you have several choices for what to do with your defined contribution pension. Providing you are at least 55 years old; you can withdraw up to 25% of your pension as a lump sum without paying tax (sometimes called ‘Tax-Free Lump Sum’ or ‘PCLS’ or ‘Payment Commencement Lump Sum’). You can leave the rest invested or use the money to buy an annuity which will then guarantee you an agreed income – this can be either for a specified period or for the rest of your life.