Why a Pension audit is vital for your wealth. (Part 2)
By David Hattersley
This article is published on: 2nd December 2015
In the previous article, I referred primarily to Pre-Retirement Planning. This article is devoted to Post-Retirement Planning ie. when you are already drawing your pension and are tax resident in Spain. For those that are lucky enough to be in receipt of a Defined Benefits Scheme (ie Civil Service / Company Final Salary Pension) most of this article will not apply to you. The same applies to those taking income from a SIPP/ Drawdown plan. This will be covered in a future article.
Primarily this article deals with “Money Purchase Arrangements” ie. Group or Personal Pensions, Stakeholder Pensions and Contracting Out of SERPs, where benefits are being taken and the tax free lump sum has been paid.
It is important to understand the taxation of income in Spain. Unlike the UK, “Earned Income” and “Capital Gains and Investment Income” are not added together to determine the highest rate of tax payable. They are kept separate with “Earned Income” taxed at the highest marginal rate, and “Capital Gains and Investment Income” capped at rates of between 20%, 22% and 24% for the tax year 2015. When one considers a person that has a State Basic Pension of £8,000 p.a. and Earned Pension Income of £12,000 (with the current rate of exchange of 1.4) it is quite easy to slip into the next highest rate of marginal tax of 31% for “Earned Income”.
One also needs to consider the rules for Lifetime Annuities by the Spanish Law “Renta Vitalicia” and its subsequent tax treatment of said income.
So why the need for a Pension audit when one is already receiving it and declaring it to the Hacienda? Are you paying too much tax as a result of the word Pension?
So does this apply to you? Possibly, and the likely reason why, is that your pension provider at retirement converted your pension to an annuity. You may have taken all the pension pots, used an open market option and transferred this to another annuity provider that offered better rates?
It is also vital to understand both the documentation sent by the UK provider on an annual basis and the treatment of pensions and annuities by the UK HMRC. Unlike the Spanish, the UK HMRC treats both pensions and annuities as one, and they are taxed under income tax rules. It is vital that this is understood. Even if you have previously informed the provider that you are living in Spain and are receiving your pension gross, due to UK HMRC rules, you will still receive a “P60 End of Year Certificate” from the provider. This clearly states under the heading “Pension and Income Tax details”.
In these cases you could be paying too much tax without realising it! As an honest citizen, one presents the P60, without having the original policy document translated into Spanish, to your local Abagado / Gestor, who in turn presents the documentation to the Hacienda. It is hard enough for them to fully understand English, let alone the tax laws relating to the UK re. pensions and how they differ to Spain. The same could be said if one is receiving advice from a UK based adviser or an “Offshore Adviser”, who are very unlikely to understand or be able to assist with the complexities of Spanish Tax law.
And the reason for this is that Spain’s tax rules treat the purchase of a Lifetime Annuity as “Investment Income” even when a “Pension Pot” is used. The full income tax law is LEY35/2006 de 28 de noviembre, del Impuesto sobre la Renta de las Personas Físicas (LEY IRPF) The specific part relating to the taxation of Annuities is found in Articulo 23 as follows:
- The taxation of lifetime annuities– Articulo 25.3 a) 2º LEY IRPF
- The taxation of temporary annuities – Articulo 25.3 a). 3º LEY IRPF
Instead of being taxed on the full income amount, a discount is applied based on the age of the recipient when the original annuity was purchased. So for someone between the ages of 60 to 65 at the time of purchase, this represents 76%. Therefore referring to the above example the taxable “Investment Income” is only £12,000 x 24% = £2,800. The £2,800 will then be subject to the lowest “Investment Income” rate of 20% (assuming no other income) ie. tax payable of £576 p.a. A very substantial saving when compared against being taxed under “Earned Income” rules. For ease, I have not calculated the rate applied if one moves into the next highest rates of marginal tax!
I have come across a number of clients in this exact situation and I am in the process of correcting this error. Already one client has had a rebate, backdated 4 years (due to the statute of limitations) and now pays substantially less tax as a result. But it is both time consuming and hard work having to track down the likes of Pearl, Equity and Law, Equitable Life, Commercial Union, Scottish Equitable, Sun Life, Clerical Medical and Eagle Star (to name but a few) who were the major providers of pensions in the 80’s and 90’s, and then confirm it was a Lifetime Annuity that was purchased.
This is further complicated by those in Final Salary Schemes like the Teachers Superannuation Scheme, who at the same time contributed to the Group AVC, and considers that the pension income comes from one source. There is the possibility that the AVC under a default process purchased an Annuity offered by the same provider.
This is a service provided for existing clients, although at some stage they will need an official translator to translate the documents into Spanish if the UK provider will not do so.
In some instances though, either because of a lack of understanding by 3rd parties ie. the Hacienda or a Gestor, some people are claiming their pension income from a QROP/ SIPP as a temporary annuity whilst still retaining control over the investment and have not actually used cash to purchase an annuity ie it is still a pension in drawdown.
This is incorrect and will be explained why in a later article. Further articles will also include “The Treatment of Small Pension Pots”, “Pensions Flexibility” and “Pensions in Drawdown”. What I have learned time and time again over the course of many years experience in the pensions industry is that the “Devil is always in the detail” and why a pensions audit is vital.
As Financial Advisers we are not professional tax advisers, but we work closely with said professionals, and in this instance the tax advice has been provided by HCS Accounting of Denia