Today is: 19 June 2013
Please note that tax law is a complex subject and you should not rely on this article without professional advice on the facts of your case.
Individuals looking to relocate to France and become non UK residents could significantly reduce their income tax liability on their pension. They could also use flexible drawdown to take a significant sum of money out of their pension fund at a much lower tax rate than in the UK. This is likely to be attractive to people with valuable pensions who want to extract all the money from their pension and hold it directly without the services of pension fund trustees. This article considers how flexible drawdown is taxed in the UK and in France when an individual becomes French resident.
Pension income only taxed in France
Generally, if an individual moves to a country with which the UK has a double tax treaty, the provision of the treaty will determine where the individuals pension is taxable. Usually, the double tax treaty will provide that income from pension is taxable only in the country where the individual is resident. This is the case where an individual becomes French resident under Article 18 of the France and UK Double Tax Treaty (France/UK DTT).
Pension lump sums also only taxed in France
It is not completely clear whether lump sum payments also fall within the scope of this article. It is possible that lump sum payments fall within other similar remuneration stipulated in article 18 of the France/UK DTT. In case it does not, there is a catch all article in the France/UK DTT which stipulates that if the treaty does not deal with a specific income, then that income will be taxable in the country of residence. Therefore, it is most likely that a French resident would be taxable in France on any pension lump sum payments.
In 2011 the UK government introduced flexible drawdown. This allows an individual to withdraw his pension fund in its entirety provided he has an annuity of at least £20,000 per year from the fund.
Flexible drawdown in UK
There are certain conditions that must be met before an individual is able to exercise the flexible drawdown. Firstly, the pension savings must be held in a money purchase arrangement (other than a cash balance arrangement) and the saving must be with a registered pension scheme. Secondly the individual must:
- be 55 years or older;
- be receiving other pension income (i.e. an annuity) of at least £20,000 pa;
- not have made any contributions in the tax year in which the declaration is made or not be an active member of any registered pension scheme under a cash balance arrangement; and
- make a valid declaration to the scheme administrator that they which to take flexible drawdown which the scheme administrator accepts.
If an individual meets the above criteria then he will be eligible and would be able to withdraw as much or as little money as they require. The withdrawal would be treated as income for tax purposes and be subject to the usual income tax rates.
The cost of a £20,000 annuity will be in the region of £330,000. This means that a person with a pension of £1 million would have £670,000 available to withdraw after buying the annuity. If the person, as a UK resident, then opts to drawdown the entirety of their pension fund they would be taxed as follows:
|0 - £34,370||@ 20% = £6,874|
|£34,371 - £150,000||@ 40% = £46,251.60|
|£150,001 - £670,000||@ 50% = £259,999.50|
Flexible drawdown paid to a non UK resident will not be subject to UK income tax. The individual will, however, be taxed on the flexible drawdown if they return to the UK within 5 tax years. In summary, if an individual became French resident and remained non UK resident for 5 years or more from the date of the flexible drawdown, they will not be subject to UK income tax.
25% tax free lump sum payment
In the UK, individuals are permitted to drawdown 25% of their pension funds tax free. However, UK nationals who live in France and take a 25% lump sum would have to pay income tax on this, although, the rate of tax would be at a lower rate than the usual marginal income tax rates in France. This special rate will also apply to the lump sum payment under the flexible drawdown regime. The best approach is to take the 25% lump sum before becoming French resident. That way there will be no tax to pay in the UK or France.
There are two aspects of the flexible drawdown which will need to be considered in France; firstly, the £20,000 per annum annuity which an individual will have to take as a condition of being able to use the flexible drawdown and secondly, the flexible drawdown amount.
As mentioned above, the £20,000 will be subject to French taxation because article 18 of the DTT provides that France has the exclusive taxing right over pension income. The applicable income tax rate will depend on the individuals marital status, age and the number of children they have. Currently, the highest tax rate in France is 41% on income above €70,830. In addition to the usual income tax rates, there is a special tax of 3% on income between €250,000 and €500,000 and 4% on any income above €500,000.
Flexible drawdown amount
Under the Projet de Loi Rectificative for 2011, a special rate was introduced on pension lump sum payment. Currently, individuals can either be subject to income tax on the entire amount of the lump sum together with their usual annual income or opt to be taxed at a flat rate of 7.5% on 90% of the lump sum in the year of receipt. The special rate is only available to individuals with one lump sum and where the original contributions were tax deductible or exempt from tax. Most UK pension funds should satisfy this criterion.
Therefore, using the same example above, if a French resident individual opts to drawdown their pension funds it is entirety following the purchase of an annuity, then he or she could be subject to 7.5% on £603,000 (90% of £670,000) which would be £45,225. This is significantly lower income tax liability than in the UK, which would be £313,124.10.
Currently, there is a UK tax charge of 35% on death. HMRC levies this tax on the pension fund trustees on the death of the beneficiary. This means a significant reduction in pension income for a surviving widow. HMRC takes the view this tax is payable even though the deceased was not UK resident at the date of death. Exercising the flexible drawdown would mean this charge is avoided because there would be no money in the pension fund to tax. It also means complete freedom over how the pension fund is used or invested in. The pension would not be subject to the UK GAD which can reduce the level of income depending on the financial/economical market.
If an individual is planning to retire or relocate to France, then it would be wise to take the 25% tax free lump sum in the UK before becoming French resident.
If the individual becomes French resident and would like to exercise the flexible drawdown facility then the costs of buying an annuity of £20,000 per annum will need to be factored in. It would also be worth noting that the special rate of 7.5% will only apply to one lump sum and so may be worthwhile drawing down the pension funds in its entirety in one.
The flexible drawdown may be a better option to a QROPS as you will have the money directly under your control and not held by the QROPS trustee.
Individuals should only consider the flexible drawdown once they have established their non UK residency. It is also important for the individual to consider their UK residency status very carefully, and ensure compliance with the residency rules in both the UK and France.