How do changes to UK Inheritance Tax affect pensions for expats?

If you have a UK pension and you live overseas, some important changes are coming.

The 2024 UK Autumn Budget announced from 2027, UK pensions will be subject to Inheritance Tax if you die.

Before this, pensions were exempt from UK IHT, and used by many as a tool to pass on wealth.

The logic said spend your pension last, as you could leave this to your beneficiaries without paying IHT.

But this logic, doesn’t remain.

The UK has moved to a residence-based IHT regime.

This means expats who’ve lived outside of the UK for more than 10 years (or 10 of the last 20 years), will only pay UK Inheritance Tax on their UK-situs assets.

But it also means those living outside of the UK, will be limited to a £325,000 Nil Rate Band.

And lose the opportunity to gift assets to their non-UK resident spouses, free of IHT.

So any UK based assets, valued over £325,000 in total, could be subject to 40% Inheritance Tax when you die.

The problem? Your UK pension is a UK-situs asset, and difficult to move abroad.

To make matters worse your pension will be hit by IHT when you die, but the people you leave it to might also need to pay Income Tax when they withdraw the funds.

A Case Study

James & Susan are British expats, who have been working Bahrain since 2012.

They have a house in Nottingham worth £480,000, and offshore investments worth £375,000.

In addition to this, James has an old workplace pension worth £250,000 and Susan’s UK SIPP is valued at £185,000.

Before the changes to IHT:

Prior to 2027, pensions are excluded from IHT.

As long term expats, they will only be assessed for IHT on their UK based assets.

This comfortably falls below their combined Nil Rate Bands.

Their total assets subject to UK Inheritance tax are £480,000 (only their UK house).

So if something happened to them, there would be no Inheritance Tax to pay.

After the changes to IHT in 2027:

Both their pensions will now be included in their UK inheritance tax calculation.

This now means their estate assessable for UK IHT is now £915,000.

If they were to die at the same time, this would result in a tax bill when they die of £104,000.

However, assuming they don’t and that Susan outlives James.

On James’ death Susan will be unable to claim the Spouse Exemption for IHT, without bringing her worldwide estate into scope for UK IHT.

So when James dies they will first pay £66,000 on his half of their estate.

Then when Susan passes away she will pay another £113,600 in IHT on her estate.

So their combined Inheritance Tax bill could be as high as £179,600.

What can you do about it?

If you want to make the most of your pension, rather than giving it to the tax man, you have 3 options:

1. Spend your pension over time

If you live outside of the UK, and are concerned about IHT on your UK assets…

The simple solution is to start spending them, before touching any assets you hold offshore.

For cash and investments, you can simply move them offshore, but for pensions it’s not so easy.

If you access your UK pension whilst living overseas, you may need to pay income tax on the funds.

This will depend on where you live now, and if there is a Double Taxation Treaty with the UK.

As an example, residents in Bahrain, Kuwait, Qatar, Saudi Arabia & the UAE, can claim relief from UK taxation on money they withdraw from their pensions.

But for residents elsewhere, the country you live in may be entitled to tax on your UK pension income. Or the UK may have the right to tax it anyway.

2. Withdraw your pension as a lump sum

For those living outside of the UK in a tax-friendly jurisdiction, for more than 5 years, there is an opportunity to claim double taxation relief and withdraw the funds in full.

In places like the UAE, this could mean paying no tax.

Or for those living in France, local tax laws allow you to withdraw the funds in full and pay a lower rate of income tax.

But to claim double taxation relief, you’ll need to get certain paperwork stamped by the local tax offices.

So it’s prudent to consult a local tax professional before making any decisions, to make sure this can be done.

In both cases, if you’ve been abroad for less than 5 years, this choice can be very risky.

Because if you return to the UK, within 5 years of leaving, HMRC might levy income tax on the full withdrawal when you return – at up to 45%.

So it requires careful attention.

3. Transfer to a QROPS

You could transfer your pension to a Qualifying Recognised Overseas Pension Scheme.

These are established in a range of countries, popular jurisdictions being Malta, Gibraltar and Guernsey.

But if you don’t live in the same country in which your QROPS is established, you’ll pay the 25% Overseas Transfer Charge when moving your pension.

This means it’s most appropriate for those who know they will never spend their pension. Where a 25% Overseas Transfer Charge may be preferable to 40% UK Inheritance Tax.

Or if you already live in a country with a QROPS scheme.

NB: Prior to 2024, you were able to transfer to a QROPS in the EEA, if you were an EEA resident, without paying the 25% Overseas Transfer Charge. This is no longer the case, you now must live in the same country as the QROPS.

HMRC provide a full list of QROPS schemes by country here – https://www.gov.uk/guidance/check-the-recognised-overseas-pension-schemes-notification-list