UK olim: Avoid 55% UK pension death tax

Your Taxes: Interaction between the UK, Israeli tax systems means that UK olim can particularly benefit from QROPS.

New olim arrive in Israel 311 (photo credit: Reuters)
New olim arrive in Israel 311
(photo credit: Reuters)
This article is especially for British olim with UK pensions.
In 2006, Her Majesty’s Revenue and Customs (HMRC) in the UK introduced Qualifying Recognized Overseas Pension Schemes (QROPS). The idea behind these was to allow more flexibility for UK expats to move their pension out of the UK.
Essentially, since 2006 you could export your pension to a tax-neutral territory such as Guernsey. There are other territories that you can move your pension to, but Guernsey is apparently the favored location for the majority of transfers.
The way that the UK tax rules interact with the Israeli tax system means that UK olim can particularly benefit from having a QROPS.
There are a number of benefits from exporting your pension to a QROPS. These can be split into two categories: during your lifetime and on death.
Lifetime benefits
Currently, new olim benefit from a 10-year tax holiday on moving to Israel. However, one of the quirks of the current tax treaty between the UK and Israel means that UK olim must continue paying tax on their UK pension income in the UK or Israel, even during their 10-year tax holiday. Thus, pensioners continue to pay tax on their UK pensions unnecessarily.
The UK pension payer deducts UK tax at source unless the oleh recipient provides confirmation from the Israel Tax Authority that the pension is subject to Israeli tax. There has been talk of a draft new UK-Israel tax treaty that would resolve this, but unfortunately that has been stalled by Middle East politics.
But if you move your pension to a QROPS, then all income payments would be made from Guernsey and no tax will be deducted in the UK. Thus, your pension income can be truly tax-free in the UK and Israel for the first 10 years of your aliya.
There are other possible advantages, such as increased flexibility and greater investment choice. However, the main lifetime benefit of a QROPS for olim is the removal of income tax for 10 years.
Death benefits
As for death benefits, HMRC changed the the UK rules last April for anyone who dies with a UK pension. At the same time, they abolished “compulsory annuitization.” Under the new rules, if you die before age 75 and have a UK pension entitlement that you have not started taking an income from, then this pension can be passed to your family with no UK tax charge. If you have started taking an income or you are over age 75 (regardless if you have started an income or not) there will be a 55 percent “tax recovery” charge applied to the value of your pension. In other words, only 45% of the pension fund can be passed to the family.
If you move to a QROPS and are outside the “reporting period” (very important, see below) then you can pass on 100% of your pension fund to your family tax-free. There is no distinction whether you have taken an income or are over 75. Everyone who is outside the “reporting period” can pass on their pension fund tax-free. This is another major advantage of having a QROPS.
However, HMRC has not been happy with the perceived abuses of the QROPS system. There have been schemes in Singapore, Hong Kong and New Zealand that have caught the eye of HMRC. Some of these schemes allowed people to “cash in” their pension pots and take out their entire fund in one tax-free lump sum. This goes against the whole point of a pension, which is designed to provide an income for life. This has annoyed HMRC.
Therefore, a few weeks ago HMRC surprised the QROPS industry with a new set of rules that are due to come into effect this April 6. They are changing the “reporting period” as well as some other rules that will force territories such as Guernsey to modify their own pension rules to comply.
The “reporting period” is the time that the UK pension must continue to follow UK rules even after transfer to the QROPS. Currently, for five years after a person emigrates, his or her pension must continue to follow UK rules on death, and the income can still be tax-free during this time. However, under the new rules, the pension must follow UK rules for 10 years after transfer. Thus, the new rules put the time limit on when the person transfers to a QROPS, rather than from when they left the UK. This will have a huge impact on olim.
For example, take someone who left the UK for Israel four years ago. If they move their pension to a QROPS now, they will be free from the 55% death charge in a year from now. If they wait and move to a QROPS after April 6, they will need to wait 10 years from the transfer date to be free of the death tax.
Another example, take someone who has been in Israel for eight years, if they move to a QROPS now, they are free immediately from the UK 55% tax charge (been out of UK more than five years). If they transfer after April, they will be subject to 55% tax charge for the next 10 years.
As you can see, the new QROPS rules could have quite a negative effect on olim. Unfortunately, HMRC has not given people much time to act before the new rules come into effect. The average time it takes to complete a transfer into a QROPS is approximately six to eight weeks.
Thus, if anyone wants to move to a QROPS under the current and more favorable rules, they need to start the process within the next few weeks.
Please note that state pensions, pensions that have been annualized and company pensions that are in payment (excluding SSAS) cannot be moved to a QROPS.
Pension transfers are extremely complicated, so it is essential that you take the appropriate advice from a suitably qualified professional.

Free seminars
For further information about these major changes to UK pensions, readers are invited to attend seminars with leading speakers in this field in Netanya on January 16 at 5 p.m. (Young Israel Shul, 39 Shlomo Hamelech Street) and in Jerusalem on January 19 at 10 a.m. (Nefesh B’Nefesh Building, 5 Nahum Hefzadi Street, Givat Shaul).
Attendance is free, but you must register through the Nefesh B'Nefesh wesbite or by calling (03) 612-3153.
With thanks to Simon Benarroch, QROPS technical adviser to Fairbairn Trust Company Guernsey, for help with this article.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.