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How the non-residence enhancement factor could reduce your tax bill when you retire

08th March 2021

If you’ve contributed to a UK pension while working abroad, you may be eligible for an enhancement to reduce your tax burden when you start taking benefits.

UK pension schemes have always had an advantageous tax status. Tax relief is payable at an individual’s marginal rate on all personal contributions, making them an attractive savings option.

Because of this, the UK government has often taken steps to limit the tax privileges available to an individual. There have always been limits on contribution levels and, in 2006, they introduced the Lifetime Allowance (LTA).

The Lifetime Allowance

The LTA limits the amount of pension benefit – income or lump sums – an individual can take from UK-based pension schemes without triggering an extra tax charge.

The LTA is currently £1,073,100 and the chancellor announced in his recent budget statement that it will remain at that figure for the lifetime of the current parliament.

  • For defined contribution (DC) schemes, which includes personal pensions and most employer-sponsored arrangements, the calculation is based on the overall value of your total pension funds.
  • For defined benefit (DB) schemes, also known as “final salary schemes”, the calculation is based on 20 times the value of your accrued pension, plus any lump sum.

How excess amounts are taxed

If your UK pension entitlement is over the LTA, you will face a tax charge based on the excess value over this amount. The way the charge applies depends on whether you receive the money from your pension as a lump sum, or alternatively as part of regular retirement income:

Lump sums

Any amount over your Lifetime Allowance that you take as a lump sum is taxed at 55%. Your pension scheme administrator should deduct the tax and pay it over to HM Revenue and Customs, and then pay the balance to you.

Income

Any amount over your Lifetime Allowance that you take as a regular retirement income attracts a Lifetime Allowance charge of 25%. This is on top of any tax payable on the income in the usual way.

The enhanced LTA can save you money

HMRC do recognise that some overseas individuals could be impacted by the Lifetime Allowance through no fault of their own, as they were not eligible to receive UK tax relief while making contributions. This also applies to individuals who transferred an overseas pension into the UK without getting UK tax relief on their funds.

Therefore, special LTA enhancement factors are available that eligible individuals can apply for.

So, if you are an internationally mobile individual who has built up entitlement to a UK pension, you may be eligible for an enhanced Lifetime Allowance.

This could save you a lot of money in tax, so it is worthwhile checking to see whether this could apply to you.

Who can apply for an enhanced LTA?

There are two ways you could be eligible for an enhanced Lifetime Allowance:

  1. Non-residence factor
  1. Recognised overseas scheme transfer factor.

We’ll be focusing on the non-residence factor in this newsletter. Next month we’ll go into more detail on the recognised overseas scheme transfer factor.

How does the non-residence factor work?

If you have built up some UK pension benefits since 5 April 2006 as an active member of a registered UK pension scheme while you have been living overseas, you may be able to claim enhanced Lifetime Allowance through the non-residence factor.

The reason for this is that you would not have been eligible for tax relief on contributions paid by yourself or your employer.

The non-residence enhancement factor is based on how much your pension increased while working overseas from April 2006 to the date you left the relevant scheme.

The calculations to determine your eligibility are not straightforward, and we’d strongly recommend that you seek financial advice on this issue.

Here’s an example of the enhancement

Ashley was a relevant overseas individual for the 2017/18, 2018/19, and 2019/20 tax years.

During all this time £105,500 worth of contributions were made by, or in respect of, Ashley.

You can calculate Ashley’s enhancement by dividing £105,500 by £1,055,000 (the standard LTA for the last tax year Ashley was a “relevant overseas individual” – in this instance, 2019/20)

The enhancement factor is therefore 0.1.

You then apply the enhancement factor to the Lifetime Allowance in the current tax year.

This means that Ashley’s enhanced LTA for the 2020/21 tax year will be £1,180,410 – the standard Lifetime Allowance of £1,073,100 plus the enhancement factor.

Key deadlines to watch out for

There are two key timescales when you are applying for the enhanced Lifetime Allowance non-residence factor:

  1. Applications must normally be made no later than 31 January following the end of the tax year five years after the end of the tax year in which the accrual period ends, or in which the recognised overseas scheme transfer took place.
  2. Secondly, those who have returned to the UK have five years from the end of the tax year in which they return to claim the enhancement. For example, if you returned on 1 February 2016 you must claim the enhancement by 5 April 2021.

We’ve really only skimmed the surface

The Lifetime Allowance and associated enhancements are extremely complicated subjects and there are various other protections and enhancements potentially available to eligible individuals.

Due to the complexity, we have only been able to briefly explain certain aspects of the enhanced Lifetime Allowance non-residence factor in this article. Therefore, we always recommend that you speak with a qualified financial adviser or tax adviser regarding your Lifetime Allowance.

Get in touch

If you would like to discuss your Lifetime Allowance options, please contact us by email or, if you prefer to speak to us directly, you can reach us in the UK on +44 (0) 208 004 4900 or in Hong Kong on +852 3903 9004.

If you have found this article informative, you may wish to read our guide to UK pensions for UK resident international citizens to find out more.

Disclaimer – Although we have taken care to provide accurate information, the article is based on our understanding only and does not constitute financial or tax advice. Government legislation can change at any time therefore information provided is as at the date of the article. Any views and information provided in the website links are not ours and may not be accurate.