Money Makeover: How can I stop tax ruining my retirement abroad?

Our reader wants to know if he should cash in his gold-plated pension to retire at 55

Tony Russell
Tony Russell would like to retire from the UK to a warmer climate Credit: Paul Cooper

The dream of retiring abroad to sun, sea and sand becomes even more alluring during the UK's winter months. But the move to warmer climes can be fraught with tax and pension pitfalls.

Tony Russell, 52, is well aware of the complex financial rules he will need to navigate to achieve his goal of retiring abroad in three years' time. But he has a plan.

He said: "The rough idea so far is to maybe move to a low tax country initially and accelerate the drawdown of my pension before settling in Europe, maybe Spain or Portugal.

"There's an option that I won't fully retire and just wind down work, but I'm keen to get a strategy around tax management. I'm also conscious of transferring pensions and mindful of the Lifetime Allowance (LTA).

"They are obviously happy problems to have, but I just want to be as efficient as possible."

The LTA is the maximum a person can draw from their pensions within their lifetime before paying extra tax, currently frozen at £1,073,100. Mr Russell is a diligent saver and right to be wary of the limit, which can trip up retirees with a surprise tax bill.

He has amassed £350,000 in his workplace pension and intends to continue contributing £40,000 each year, for the next three years. He makes the most of his Isa allowance each year, saving £20,000 into stocks and shares.

Mr Russell also has a defined benefit pension which will pay him £24,000 a year, based on its latest valuation. Under the scheme rules he has been allowed to access the pension since he turned 50. These pension pots are often referred to as "gold-plated" as they pay income for life, which rises annually with inflation.

Mr Russell said: "I'd be interested to know if there is any advantage to transferring my defined benefit pension into my defined contribution pot. I understand this is generally not advisable, but wondered if there was any benefit because of the plan for an accelerated draw-down abroad.?

He and his wife have budgeted living on £40,000 a year in retirement, but this could drop if the cost of living is cheaper in Europe compared to the UK.

Dennis Hall, chartered financial planner at Yellowtail Financial Planning

Weighing up whether to transfer from a defined benefit pension is difficult and transferring overseas creates even more complexity. The transfer value of £809,082 given in January last year suggests transferring could have been a consideration, but as interest rates have risen, transfer values have fallen, some by as much as 40pc. What may have been a good idea one year ago has now been turned on its head.

The overseas scheme you transfer your pension to must be a "qualifying recognised overseas pension scheme" (QROPS). If it's not a QROPS, your UK pension scheme could refuse to transfer, or you'll have to pay at least 40pc tax on the transfer. Even if it is a QROPS, if you live outside the UK, the European Economic Area or Gibraltar (or move outside these areas within five years of the transfer) you will pay 25pc tax.

The guarantees of a defined benefit pension are often significantly undervalued by members. Mr Russell must not underestimate the long-term effects of inflation on his pension pot over his lifetime or overestimate the ability to generate investment returns on his pension funds. Over the long term it would be a recipe for disaster.

Mr Russell's defined benefit pension and UK state pension will cover most of his anticipated living costs from state pension age. The period between stopping work, moving overseas and these pensions kicking in could then be covered by aggressively drawing down on the defined contribution pension. The tax implications remain the same, so there is probably not any merit in temporarily moving to a low tax regime from a pension perspective.

He should bear in mind the costs of moving pensions from one scheme to another and the ongoing charges that will be applied. Some of these offshore plans have eye-watering charges.

We've been brought up to believe "a bird in the hand is worth two in the bush" but with pensions this is rarely true.

Jason Porter, chartered tax adviser and business development director at Blevins Franks

Moving abroad means a new tax system and new financial rules and regulations. But making the move should not get in the way of it being a time in your life for enjoyment - and a well-funded pension will help achieve that goal.

His two pension schemes will hopefully mean his income requirement of £40,000 a year in retirement is met.

Any decision on the defined benefit pension maybe best deferred until much nearer Mr Russell's retirement date. Not only can an awful lot change in three years, but also any analysis would benefit from pension fund values and projections much closer to the actual date of crystallisation.

If Mr Russell does move abroad then he may choose to dispose of his Isas before he leaves. They do not have tax-favoured status in other jurisdictions. Selling these before he and his wife leave the UK will also mean no tax will be payable on the disposal. Mr Russell will need to understand the UK's statutory residence test (SRT) to determine when their UK tax residence ceases and how many days they could spend back here in the following years.

For the first few years the couple are unlikely to satisfy either of the SRT automatic tests, so the "ties" which they have with the UK will be important. Keeping a property in the UK which they could live in is one tie.

But Mr Russell should look at the other tests to understand how many days he will be restricted to. With regards to possible wealth tax implications of moving abroad, in states like France and Portugal it is only the value of real estate that is relevant, so UK and overseas property, less any mortgages if living in France, will be relevant here.

Other countries such as Spain have a wider definition, including other assets like cash and those in a regular portfolio like shares, bonds and investment funds. A recent ruling by Spain's Directorate-General for Taxation also determined "third country" pensions were liable to wealth tax.

Reader Service: Wondering how much money you can send abroad? Learn how to make an international money transfer online