adviser guide blueprint Retirement Plan Superannuation Service Transferring UK pensions Contents INFORMATION FOR ADVISERS blueprint Technical

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1 INFORMATION FOR ADVISERS o c t o b e r blueprint Technical blueprint Retirement Plan Superannuation Service adviser Contents guide Transferring UK pensions 1 Introduction 1.1 Origins of Pension schemes in the UK 1.2 Origins of Superannuation schemes in Australia 1.3 UK versus Australia 1.4 Opportunities in transferring to Australia 1.5 To transfer or not to transfer 2 current United Kingdom Pension Plan features 2.1 Pension Scheme (Benefit) Types 2.2 The post 6 April regime in the United Kingdom 2.3 Accessing Pension Benefits 3 transferring UK pensions to an Australian fund 3.1 Qualifying Recognised Overseas Pension Schemes (QROPSs) 3.2 Eligibility to Contribute 3.3 Restrictions on benefit payments 3.4 Transfer value determination 3.5 SMSFs and QROPSs 4 Tax Implications of the transfer 4.1 Australian tax resident 4.2 Foreign Investment Funds tax provisions 4.3 Calculating the Growth components 4.4 Making an election after transfer 4.5 UK plan does not provide historical values 5 Superannuation Contribution Caps 5.1 Breaching the Contribution Cap 5.2 Manoeuvring around the Contribution caps 6 Other considerations 6.1 Income Tax 6.2 Insurance 6.3 Centrelink 6.4 Family law splits 6.5 Death Benefits payments 7 Recommending a transfer to Australia

2 1 Introduction The retirement policies of the United Kingdom (UK) and Australia share common ground. Both countries have addressed the problems arising from an aging population and an increasing dependency on age pensions. So why does the treatment of retirement funding differ so greatly between the two countries and why is there such a complex set of rules and regulations for transfers from UK pension plans to Australian superannuation funds? The differences have occurred because, while each system tries to tackle the same problem, each has fundamentally different origins and each successive policy decision has tried to address current or anticipated issues while still trying to ensure equitable treatment of legacy members. Coincidently they have tried the same approaches, but at different times. Both governments have recently attempted to address the complexities by introducing a simpler system. 1.1 Origins of Pension schemes in the UK For many years the UK had a compulsory National (or State) Pension Scheme to which a person contributed throughout their working life. It was a defined benefit, formula-based pension scheme which was portable at an individual level as they changed employers. This rudimentary scheme which provided a basic pension was then subsequently refined by the addition of salary related schemes. Later these refinements were permitted to be contracted out to the private sector. The underlying equivalent capital value basic National (or State) Pension can never be transferred overseas, however pensions in private schemes including those with contracted out rights can now be transferred out of the UK. 1.2 Origins of Superannuation schemes in Australia The Australian equivalent to the National (or State) Pension is the tax payer based Centrelink Age Pension. This has been provided under the provisions of various Social Security legislation currently the Social Security Act 1991 as amended. The first Commonwealth aged pension came into operation 1909, superseding State age pension schemes which had been introduced in New South Wales (1900), Victoria (1900) and Queensland (1908). The Age pension is means tested but is still available to all Australian citizens. On the other hand membership of an employer s superannuation fund was by invitation or stated eligibility requirements and there was no requirement to keep benefits in superannuation on leaving an employer, with some exceptions, notably the public sector funds of the Commonwealth and Australian States. Initially originating from defined benefit plan funds, the market penetration of private sector schemes was very small. However the introduction of 3% employer contributions as a condition of industrial awards, from late 1986, then Superannuation Guarantee contributions increasing the 3% to a universal 9% for employees from 1992 has accelerated market participation, so that now over 90% of the working population have superannuation accounts. 1.3 UK versus Australia The fundamental differences between the UK and Australia are that: Accumulation account based plans dominate employer funded superannuation in Australia, since a period of high inflation in the 1970s, while in the UK defined benefit schemes are still far more prevalent, with the extra factor that they are life pension benefits, so that the fund carries members longevity risks, as well as investment risks, which can greatly complicate payment of transfer value lump sums. The ability for Australians to access superannuation lumps sums has meant that they were the most popular form of payment in Australia until the advent of account- based allocated pensions, whereas in the UK the intention was to provide an income stream in retirement for life. While use of account-based pensions in Australia is becoming predominant, concerns for living too long are now emerging here as well. 1.4 Opportunities in transferring to Australia There are some 1.3 million British migrants who are permanent residents of Australia and a large number of Australians who have worked in the UK who have accrued benefits in retirement funds in the UK. Both these groups represent a growing opportunity for 2

3 1 Introduction (continued) substantial gains in funds under advice for Australian financial advisers, as evidenced by the increasing interest in the transfer of UK pension account values. While the opportunity is available, the complexity of both systems may initially seem too overwhelming to consider exploring transferring the benefits, for the client, and facilitating that transfer, for their financial planner. There are however many advantages to transferring UK pension monies to Australia, including consolidation and control of assets (including flexible estate planning and removing exposure to exchange rate movements on a substantial asset) and concessional tax treatment in superannuation. Control This includes control over investment strategies, income streams and estate planning. Many schemes in the UK, particularly employer schemes, are defined benefit schemes, with the further complexity of being defined pension benefits, not lump sums. The investment choices and eventual payment amount are determined by the provider. When a UK fund is transferred to an Australian superannuation fund, it becomes part of the client s accumulation benefits and enjoys all the freedom and benefits clients are familiar with in Australian superannuation, such as; investment choice, insurance choice, account-based pensions (including Transition to retirement) and lump sum withdrawals. UK defined benefit scheme pension payments are usually life-time benefits. These schemes pay an income stream but cease on the death of the last of the member or their spouse. There is often no residual value available for the estate. Compared to these UK schemes Australian superannuation which provide much wider options for estate planning including reversionary pensions and lump sum death benefit payments seem far more attractive. Concessional tax treatment In Australia there is concessional tax treatment on earnings and capital growth while a client is in superannuation. There is also concessional treatment on withdrawals from preservation age and withdrawals after age 60 are tax-free. Further, once they have migrated to Australia, a client who retained their pension fund interest in the UK will have the growth in value of the interest exposed as Australian assessable income either each year or on eventual transfer, which is taxed at their marginal tax rate. If the client retains their UK pension interest until they retire, and then receives an income stream from the UK pension plan, all or most of the income is assessable for Australian income tax, regardless of the client s age. 1.5 To transfer or not to transfer While the advantages seem obvious, any advice on moving from one financial product to another cannot be given without due consideration of the particular benefit to the client. However the complexities and the differences in the two systems can make this a challenging task. The purpose of this Adviser Guide is to provide an overview of the UK and Australian systems to facilitate a better understanding of the choices available to your client. Where a client asks you specifically whether they should transfer funds from their UK pension plan to their Australian superannuation, the Australian requirement to know the product they are transferring from still applies. Specifically we will be addressing: The United Kingdom Pension system including some of the legacy issues that have created complexity when completing a transfer to a Qualifying Registered Overseas Pension Scheme ( QROPS ). The Australian requirements, restrictions and opportunities The forms and procedures required to complete a QROPS transaction 3

4 2 Current United Kingdom Pension Plan features On 6 April 2006 the UK implemented a simplified pension regime. The UK Registered Pension Scheme (previously known as UK Tax Approved Pension Scheme) is the equivalent of the Australian Complying Superannuation Fund, for access to taxation concessions in the UK. It includes personal, stake-holder and occupational pension schemes. Similar to our own preservation rules, the UK regime has conditions of release for access to benefits. Its early retirement age is currently age 50. On 6 April 2010 the minimum age for taking early retirement increases from 50 years to 55 years. (See for more detail.) The features and restrictions of the UK regime for pension plan tax concessions are explored in this section. 2.1 Pension Scheme (Benefit) Types There are four main types of pension scheme benefit types. They are: National Pension (National Insurance) Plan Defined benefit schemes Defined contribution schemes Hybrids National Pension (National Insurance) Plan This is the basic State Pension and nearly everyone in the UK can expect to get a basic State Pension when they reach State Pension Age. It cannot be transferred overseas. It is formulated on years worked in the UK, but not salary levels State Second Pension (S2P) and SERPS These are salary related defined benefit schemes where contributions are made for the individual, usually by their employer. It is fully portable and moves with the individual s employment. Though also known as the State Pension, later versions known as SERPs (State Earnings Related Pensions) and S2Ps (State Second Pensions) have been contracted out to the private sector and became known as Protected Benefits or Guaranteed Minimum Pensions (GMPs). From 6 April % of these benefits can be transferred overseas if requirements are met. However, if the value of the underlying investment assets of the pension fund do not support a minimum transfer value determined by regulation, a pension plan will not pay money out until a UK condition of release is met. With the current depressed value of investments world wide, this restriction may come into play with more prospective transfers than before the market crash Defined Benefit Schemes Many employer plans in the UK are still defined benefit, salary related schemes (or Final Salary) where the member s retirement benefit is based on service with the employer and their salary close to retirement. The employer undertakes to make contributions at a level advised by an actuary to keep the fund able to pay benefits. This means that the employer effectively carries the ongoing investment risk, and because benefits are life-time pensions, and are also exposed to the risk of retirees living too long. Employer plans are known by various names in the UK, including Occupational Schemes and may include protected benefits, which can be transferred at the UK provider s discretion Defined Contribution Schemes Also known in the UK as Money Purchase pension schemes, because the accumulation at retirement purchases a life-time pension or annuity, they are similar to our account-based schemes up to retirement, and can be based on both employer and personal contributions. Defined contribution schemes may include protected benefits, however the member takes the investment risk and the pension is dependent on the cost (of the annuity) and the capital available. The protected benefits can be transferred at the UK provider s discretion. Examples of these schemes include Company, Stakeholder, Personal Pension schemes and Additional Voluntary Contribution Arrangements (AVCs) Hybrids As the name suggests, these are simply a combination of defined benefit and defined contribution schemes, similar to pre-retirement funding for some of the remaining Australian defined benefit employer plans that have added an accumulation section for additional personal and salary sacrifice contributions. 4

5 2 Current United Kingdom Pension Plan features (continued) 2.2 The post 6 April regime in the United Kingdom Contributions to pension schemes Similar to the Australian regime though there is no upper limit on individual and employer contributions, but there is an upper limit on the amount that can participate in the tax concessions Contributions annual allowance The annual allowance is a yearly limit on the total contributions made by an individual or their employer to a registered pension scheme that can be claimed as a tax deduction. (Interestingly the limit doesn t apply in the actual year of retirement, allowing large contributions just before retirement.) Individuals get tax relief on their own contributions up to the lesser of the Annual Allowance or their full level of earnings. As there is no restriction on multiple memberships, contributions are aggregated across all pension schemes. Where funding exceeds the annual allowance, an annual allowance charge of 40% is levied on the amount over the allowance limit. Tax year (commencing 6 April) , , , ,000 Annual allowance Annual Allowance & Defined Benefit Schemes The Annual Allowance for Defined Benefit (DB) schemes is a deemed capital value amount of the year s additional retirement benefit recognition. This is determined by first working out the difference between the accrued pension at the start of the year and the end of the year, then multiplying the difference by ten Annual Allowance & Defined Contribution Schemes The Annual Allowance for accumulation or Defined Contribution (DC) schemes is valued as the contributions that the individual and/or employer pay into the scheme(s) over the tax year Benefits Lifetime Allowance From 6 April 2006 there has been a standard lifetime allowance, which is the maximum amount of pension savings that can benefit from tax relief (introduced just as Australia was abandoning its Reasonable Benefit Limits). Initially set at 1.5 million for the 2006/07 financial year it increases over time as follows: Tax year (commencing 6 April) Annual allowance million million million million The lifetime allowance is based on the approximate amount of money needed to purchase a pension equal to the maximum that legislation permits under the tax regime. For occupational scheme benefits the initial lifetime allowance of 1.5 million set in 2006/07 was broadly the amount required to provide maximum benefits for a 60 year old with earnings at the earnings cap of 105,600 in 2005/06. Excess funds are considered to have unduly benefited from pension tax concessions and a tax charge is made on the excess amount. Funds that exceed the lifetime allowance can be taken as a lump sum but a lifetime allowance charge of 55% will be levied on the excess. Transferring a UK pension to Australia is treated as taking a lump sum. Similar to Australian RBLs, the Lifetime Allowance takes into account all benefit payments, so that older clients may have used some of their Lifetime Allowance before you examine their potential transfer value.) Where the excess is taken as a pension, a lifetime allowance charge of 25% is levied on the excess. The income would also be subject to income tax at the individual s marginal rate. Any liability for a Lifetime Allowance Charge falls jointly and severally on the individual and the administrator (that is the pension scheme). Therefore any charge will generally be settled by the pension scheme, usually by converting sufficient pension into a lump sum to settle the liability. 5

6 2 Current United Kingdom Pension Plan features (continued) Valuing Pension Benefits All benefits are valued by the HRMC for the purposes of the Lifetime Allowance. Where a member has multiple interests, HRMC considers the value of all the benefits together. The lifetime allowance is tested on a defined contribution basis therefore Her Majesty s Revenue and Customs (HMRC) converts any defined benefit schemes to a defined contribution based capitalisation amount Lifetime Allowance and Defined Benefit Schemes The capital value of a defined benefit pension is calculated by multiplying the per annum retirement amount by a valuation factor. Type of pension Accrued pension in Defined Benefit scheme Pre A-Day* pension in Payment Defined Contribution pension Fund (e.g. money Purchase and AVCs) Valuation factor ( pension fund : pension p.a.) 20 : 1 25 : 1** Value of benefits in Fund * A-Day = 6 April 2006 ** The higher pension factor is to take into account any cash lump sum benefits an individual may have received The valuation factor of 20:1 used by HMRC represents a gross income of 75,000 per annum on the lifetime allowance of the 1.5 million. The pension scheme, in settling the liability for Lifetime Allowance charge, may use different conversion factors to HMRC, but these should be set out in the scheme rules. It is also important to note that the deemed value as calculated above may be different from the market value Protection Members of UK Registered Pension Schemes who are close to or higher than the Lifetime Allowance limit are able to protect their benefits by registering for protection as at 6 April They have until 5 April 2009 to register for protection. (This is similar to the Transitional RBL provision in Australia when RBLs went from a multiple of salary basis to dollar amounts.) They can register for Primary Protection, Enhanced Protection or both Primary Protection The individual is registered for a personal lifetime allowance equal to the deemed value of their retirement benefits at 6 April This option is only available if the individual s funds were worth more than 1.5m on 6 April Primary Protection cannot be lost Enhanced Protection This provides full protection for all existing benefits at 6 April 2006 and also allows for increases. Enhanced Protection for defined contribution schemes will be based on investment returns and for defined benefit schemes it will be in line with salary increases (or, if better, the higher of 5% p.a. and RPI). Enhanced Protection can be lost at any time as a consequence of certain actions. For instance, any post 6 April 2006 contributions by or in respect of an individual with a money purchase arrangement will invalidate Enhanced Protection. 2.3 Accessing Pension Benefits Early Retirement Age Currently the minimum age for early retirement accessing benefits is 50. From 26 April 2010 the minimum age will increase to age 55. Individuals born between 5 April 1955 and 5 April 1960 will have to wait until age 55 unless they have retired prior to 6 April Those born after 5 April 1960 will not be able to retire until aged 55. Note: Any pension scheme whose members on 10 December 2003 had a right to retire at an age earlier than 55 and members with the same right who joined the scheme between 10 December 2003 and 6 April 2006 may still keep those rights. The difference between their UK access age and their Australian preservation age can be of concern to many clients, and should be explained carefully. The table below sets out the comparative minimum access ages. 6

7 2 Current United Kingdom Pension Plan features (continued) Date of birth Australian preservation age UK minimum pension age Before 6 April April June July June July June July June July June July 1964 or after Maximum Retirement Age The maximum retirement age is 75, when the individual must start a pension or take benefits as a lump sum where available. Lifetime pension/annuity type income streams and retirement income payments for a member under age 75 are from account-based pensions and categorised as Unsecured pensions. Similar account-based payments can continue beyond the member s 75th birthday but with more a restrictive calculation basis, such as an Alternatively Secured Pension Cash Lump Sums at Retirement Ignoring any special protection and subject to the rules of the pension scheme, the pension simplification rules allow an individual to take a tax free lump sum from each arrangement they are in, up to the lower of: 25% of the standard lifetime allowance, less any benefits taken; or 25% of the deemed value of the retirement benefits taken Early Retirement Due to Ill Health Access to benefits due to ill health will be decided by the Trustees of the Pension Scheme although medical evidence may be required by HRMC. 3 Transferring UK pensions to an Australian fund There are special provisions for a transfer between complying UK pension plans, and also from UK pension Plans to plans in other countries with similar retirement savings regimes. Australia is not one of these countries. For transfers outside of these countries, the receiving retirement savings plan must apply to Her Majesty s Revenue and Customs (HMRC) to be recognised as a QROPS. 3.1 Qualifying Recognised Overseas Pension Schemes (QROPS) Allowing a transfer A superannuation or pension fund in any country can request to be recognised as a QROPS. A fund (scheme) which seeks to be registered with Her Majesty s Revenue and Customs HMRC as a QROPS must satisfy a number of strict criteria: It must be a scheme for retirement purposes It must comply with the local regulatory regime for such schemes It and its benefits must be exposed to local tax in certain ways. Australia has been allowed to qualify even though there was some initial concern over pension payments after age 60 being tax free. It must give an undertaking to HMRC that it will comply with UK QROPS benefit reporting requirements. If a UK pension scheme breaches UK regulations by transferring benefits (particularly protected benefits) to a non-qrops scheme the transfer may be deemed an unauthorised payment and subject to penalty tax up to 55%; consisting of a 40% Unauthorised Payment Charge and a 15% Payments Surcharge. If a client s UK transfer proceeds in an Australian fund are transferred to a non-qualifying fund (within the 5 year rule), the transfer may also be deemed an unauthorised 7

8 3 Transferring UK pensions to an Australian fund (continued) payment and subject to the above tax penalties. The Australian QROPS may also lose their registered status and will cease to be qualified to receive further transfers from the UK. Generally most UK funds will transfer to any Australian complying superannuation fund that is (also) a QROPS. Each QROPS is issued with a QROPS number and UK plans may ask for the number or a copy of the HMRC s acknowledgement of QROPS status. These are available on request Exceptions to allowing a transfer There are certain instances where a UK fund will not allow a transfer. The fund may not allow a transfer where: A pension has already been commenced If the UK pension is in drawdown phase, even if the trustee is aware that the individual is retired the UK fund, to guard against selection against the fund, usually will not allow the transfer Protected rights These may be identified in your client s annual statements, and transfer value quotes, as Protected Rights, and Guaranteed Minimum Pension or GMP entitlements. In some instances the income from the protected rights portion can only be taken as an annuity income and cannot be taken as a lump sum. However recent changes mean most UK funds will allow the transfer of GMP funds to an Australian fund. These rights have a minimum pension value at retirement and a discounted value before then. If the present value of the share of the scheme assets underlying the funding of that discounted value is less than the formula value, the fund does not have to meet the guarantee and/or release a transfer value for these rights before retirement age. With the current state of world asset markets, this may well arise for current transfers Uncertainty of residency The UK fund will only transfer funds if they are confident that the person intends to reside in another country permanently. They may ask for dates and proofs of residency. Ultimately only the administrator of your client s particular UK fund can confirm whether they will transfer the funds. Your first letter to them on behalf of the client should include a question on whether they will pay a transfer value. 3.2 Eligibility to Contribute Transfers to an Australian superannuation fund from overseas, outside the Australian retirement savings regime are not rollovers. Under superannuation law in Australian, transfers from the UK are treated as contributions and consequently subject to the eligibility requirements (including the work test after age 65) and the contributions caps. If a person is between 65 and 75 years a super fund can only accept the transfer if the person has been gainfully employed on at least a part-time basis, ie. at least 40 hours in a 30 consecutive day period in the financial year that the transfer is made. All of the transfer value may be non-concessional contributions, or part may be excluded from the caps using a special election. This is discussed further below in Restrictions on Benefit Payments Once the UK pension funds are transferred to a QROPS, they retain some of their identity for UK tax impacts for up to 6 UK tax years ( starting from the April prior to transfer). They can be rolled over to another Australian QROPS within this period but must not lose their identification as QROPS money. At the same time, the benefits are subject to Australian superannuation law preservation requirements that a SIS condition of release has to be met for the member to access the funds. The additional restriction imposed by UK legislations means that to avoid a possible penalty of 55% on a benefit withdrawal, a person must not have been a UK resident in the current UK tax year as well as the previous 5 consecutive UK tax years. The UK tax year runs from 6 April to 5 April. The period starts when the person ceases UK residency, not from when the transfer occurs or when Australian residency commences. One suggestion to explain the point of this provision is that it tests that the individual has left the UK for good. 8

9 3 Transferring UK pensions to an Australian fund (continued) Because of the potential for a UK migrant to return to the UK for long enough to become a UK tax resident again, the Administrator requests a declaration that the 5 year rule has been met before releasing money transferred from the UK. The 55% penalty tax consists of an Unauthorised Payments Charge of 40%. There is a further Unauthorised Payments Surcharge of 15% if the transfer value exceeds 25% of the pension within a 12 month period. Clients may have made contributions to their Australian super fund, as well as transfer their UK fund. UK provisions are specific that where there is a UK transfer as well as a value accumulated in Australia, the first benefit paid out of a QROPS must be from the UK transfer value. Therefore the Australian accumulation amount maybe not be available for the first 5 years. 3.4 Transfer value determination Your client should be receiving annual statements from their UK pension plans, as long as they have advised them of their current, Australian address. Most of these will show prospective retirement pension values per annum, and will also show a present lump sum value of benefits. Lump sum values will be shown for defined benefit pension plan benefits as well as for account-based, contribution accumulation plans. Unfortunately in neither case is this a good indication of the transfer value available at the date of the statement. For defined benefit pension plans, the stated lump sum is a discounted value of the service recognition to the date of the statement, and its increase from year to year is merely indicative of the growth in value of the building end benefit. When payment out of a lump sum value is actually requested for transfer, an asset adjustment discount factor or a similarly named reduction can often be applied (and is more likely in the current financial market situation), to reflect the difference between the plan trustee s long-term expectation of the value of underlying assets funding the plan s pensions, and the current realisable values. Even for account-based pension plan values, an asset adjustment discount factor may be applied to statement values quoted for the member s ongoing information. While the application of an asset adjustment factor may be disappointing for the individual, the depressed transfer value will result in a substantially reduced exposure to Australian tax on transfer for a client with significant funds still in a UK employer-sponsored plan. It should be noted that we have seen many funds charge a substantial fee for the quotation of multiple transfer values within one fund year, advising only one free quote a year per member. Both this and the need for transfer values from years or even decades before transfer for Australian tax requirements discussed below can cause complications. 3.5 SMSFs and QROPSs A Self Managed Superannuation Funds can become a QROPS, provided the trust deed does not prevent it and the trustee(s) are prepared to meet the requirements of a QROPS. Many British migrant SMSF members find it easier to move funds to an existing retail QROPS scheme and transfer the funds to the SMSF after they complete the required period out of the UK. 9

10 4 Tax Implications of the transfer All investments held overseas by an Australian Tax Resident come under the Foreign Investment Fund measures (FIF). This includes retirement funds held overseas, and other trusts. Therefore the first question to be answered is one of residency: who is an Australian tax resident? 4.1 Australian tax resident In the context of tax, Australian resident means Australian resident for tax purposes. Determining residency of an individual for tax purposes is tax advice and cannot be fully addressed here. However there are some ATO publications such as Tax Ruling IT 2650 for those departing Australia and TR 98/17 for those entering Australia that provide guidance for individuals to determine their own status. Advice from a tax professional should be sought if a client is uncertain about their status. Tax residency is not the same as citizenship. There is no conclusive test in determining a person s residency for tax purposes, but there are guidelines and determining factors. Individuals can be dual residents for tax purposes and relief from double taxation on some income may be provided through double tax agreements (DTAs). There are four residency tests: 1. Residence: the primary test looks broadly at whether a person resides in Australia in the ordinary sense of the word. To reside is to dwell permanently, or for a considerable time; to have one s settled or usual abode, to live in particular place. So this is usually a matter of fact, unless an individual spends a substantial amount of time elsewhere on a similar basis. This can apply to migrants, teaching and studying academics, students, people on pre-arranged employment contracts and even tourists and it looks at the behaviour of the person while they are in Australia. That is, are their day to day activities in Australia similar to their activities before entering the country? Only if the residency test is not met, does the person need to look at the other three tests. 2. Domicile: A domicile is considered by law to be your permanent home, and usually something more than a residence. A permanent place of abode is simply a permanent place (not temporary or transitory) where a person resides, i.e, lives and sleeps. While you can reside in many places, you can have only one domicile at a time. This seems to give some choice to an individual who spends time in 2 or 3 locations, to select one of them. This test generally comes into play if an Australian resident goes overseas for an extended period of time day test: considers the physical presence in Australia during the income year. 4. Commonwealth superannuation: contributing members of Commonwealth super schemes will always be residents, as will the member s spouse and any children under age 16. Generally, a person who has come from overseas becomes an Australian resident for tax purposes if: they have moved to Australia to live here permanently they been in Australia continuously for six months or more and for most of the time they have been : in the one job, and living in the same place, or been in Australia for more than half of the financial year, unless their usual home is overseas, and they do not intend to live in Australia. The first two situations are more likely to be applicable where a client wishes to transfer their UK pensions across to Australia. 10

11 4 Tax Implications of the transfer (continued) 4.2 Foreign Investment Funds (FIF) tax provisions Essentially any growth in value of foreign investments must be declared as assessable income in Australia the default position is that individuals should declare this in their tax return for the tax year in which it was earned. However there are some exceptions to FIF which are particularly applicable to superannuation transfers: 6 Months exemption. If the superannuation funds are transferred to Australia within 6 months of the individual becoming an Australian resident, the growth for that period does not have to be declared for Australian taxation. Exemption for an interest of $50,000 or less. If clients (and their associates) have less than $50,000 in total in Foreign Investment Funds and foreign Life Policies they are considered a small investor and are exempt from taxation each year on any growth in value during that year. Associates include spouses and children. Exemption for employer-sponsored foreign superannuation. If the super fund is maintained by the employer (or associate) and the client was once an employee, then the client need not declare their annual earnings each financial year. They can instead declare the entire growth (from the day they became an Australian resident for tax purposes) for taxation once it has been transferred to an Australian fund. The foreign superannuation fund does not need to be a corporate fund to be classified as an employersponsored fund. As long as it received some employer contributions it qualifies. Unfortunately many UK corporate funds transfer benefits to a personal transfer policy selected by the individual, out when an individual ceases to be an employee, to a so that they lose this deferment option. 4.3 Calculating the Growth components Where a transfer occurs more than 6 months after a person become an Australian resident, the transfer amount may have a growth component which will be assessable on transfer. The growth component is calculated differently depending on whether the overseas account is: a personal scheme not exempt from the annual FIF tax requirements an employer scheme, or a personal scheme exempt from the annual FIF requirements Personal superannuation schemes not exempt from annual FIF tax requirements The growth in value of the UK pension plan interest must be determined for each completed financial year that the client is an Australian resident and this amount is taxed in their annual tax return. However, on transfer to an Australian superannuation fund within a financial year, the assessable amount of the transfer is calculated from 1 July of that financial year. Generally this will be the transfer value on transfer date less the transfer value on 1 July with the difference converted to Australian dollars at the currency prevailing on the date the transfer occurs. This will be the growth amount that can either be taxed in their annual tax return, or an election made to have it taxed in the super fund at 15% (refer section 4.4). Employer sponsored schemes and non-fif exempt personal schemes These schemes are not subject to annual FIF requirements, however on transfer the assessable amount has to be calculated from the date they became an Australian resident. To calculate the growth amount of the transfer, the following process is followed: determine the amount actually transferred to the Australian fund, determine and subtract from the above the transfer value on the day the client became an Australian resident subtract any contributions made since they became an Australian resident convert the result into Australian dollars at the prevailing exchange rate on date the transfer occurs Note that if any withdrawals have been made from the overseas scheme during Australian residency, further calculations may be required. 11

12 4 Tax Implications of the transfer (continued) 4.4 Making an election after transfer There is a special provision that applies for the growth component of the transfer value as discussed in Section 4.3. The FIF provisions do not apply to the growth amount, but rather the client has three options once the funds have been transferred to an Australian fund: Declare the growth for this last period in their tax return and pay personal income tax at their marginal tax rate Make an election to have the growth component taxed within the super fund at 15% A combination of the two above. Making an election may be an attractive prospect for clients whose personal marginal tax rate is higher than 15% and/or do not have the cash outside of superannuation to meet the tax liability. The election amount becomes a taxable component and further, does not count towards the non-concessional cap or the concessional cap. However it must be kept in mind that this election is only available when the individual ceases to have any interest in the overseas fund and all of the benefits are transferring to Australia, and the benefits are transferred directly to the Australian complying superannuation fund. This can cause a problem for large transfer values in excess of the person s non-concessional contribution cap level, as the amount not elected to be assessable income of the Australian fund is to be caught by the non-concessional contributions cap. The Australian superannuation industry raised this as a matter of concern with the government almost immediately after the announcement of the Better Super changes and continues to press for more appropriate treatment. We discuss the contribution cap implications in more detail in Section 5. The form and instructions (Nat 1174) for making the election are available on the ATO website or by contacting the Administrator s Technical Team on Any completed form is simply lodged with the receiving Australian superannuation fund. 4.5 UK plan does not provide historical values If after repeated attempts the UK fund has been of little help in providing a transfer value as at the time a client became an Australian resident, the client may have little option but to make a reasonable attempt to estimate the growth with the information that is provided. An actuary may be able to assist. Depending on the type of UK scheme, such estimates could be made by discounting back from the final transfer value. For a particular plan this may involve: Assumed average annual investment earning rate for Money Purchased Plans account-based schemes, and assumptions about the amounts contributed each year. The service recognition rate per year for defined benefit pension plans, and Deferred Benefit Indexation Factors. These may be based on the UK RPI (Retail Price Index) or be a fixed percentage. (The basis for these factors is often stated in the plan s annual statements.) 12

13 5 Superannuation Contribution Caps Overseas transfers are considered contributions when received by Australian superannuation funds. They cannot be treated as rollovers as that is a term specifically applied to the movement of benefits already accrued within the Australian superannuation system. Concessional Contribution Cap No part of an overseas transfer counts towards the concessional contribution cap. Non-Concessional Contribution Cap If an individual does not use the tax election discussed in Section 4.4, the entire transfer amount is counted towards the non-concessional contributions cap. If an individual does make use of the election, only the non-taxable amount of the transfer will be counted towards the non-concessional contributions cap (for tax purposes). Any transfer will impact on a client s ability to otherwise use their non-concessional contributions cap. Utilising any available election on the growth component reduces the amount measured against the non-concessional contributions cap, as the elected amount is not non-concessional contributions for tax purposes. A transfer amount that exceeds the non-concessional contributions cap results in adverse taxation consequences of 46.5% on the excess. Depending on the amount, a strategy to transfer funds in instalments over an extended period may need to be used. Strategies and consequences are considered later in this chapter. 5.1 Breaching the Contribution Cap While the commissioner has the discretion to disregard or re-allocate contributions in special circumstances, a breach of the caps as a result of an overseas transfer is not considered a special circumstance. Even where the breach of the cap has been as a result of fluctuations in the exchange rate, the commissioner will look at the surrounding circumstances to see whether it would have been reasonable to expect a breach and if it could have been avoided, before making a decision. (PS LA 2008/1). Where the non-concessional cap has been breached, the member will be liable for an excessive non-concessional contributions tax of 46.5%. The member is personally liable for meeting this liability, but they are required to request their super fund to release the money required to meet the liability. HRMC has recently clarified that it sees these releases from the Australian superannuation fund as unauthorised payments for UK purposes. It based this on a view that the member is personally liable for excess non-concessional contributions tax of 46.5%, and the payment from their Australian superannuation fund is accessing the QROPS transfer amount to meet this liability. Note: this is only an issue if the member has left the UK for less than 5 UK tax years. HMRC has stated that payment of normal contributions tax, including the 15% fund tax liability on any part of the transfer value elected to be taxable by the individual is a liability of the Australian superannuation fund, and not an unauthorised payment for UK purposes Restrictions on single contributions above the Non-concessional cap Overseas transfers are treated as contributions for eligibility to be accepted by a superannuation fund under Superannuation Industry (Supervision) Act (SIS) provisions. In addition to the work test requirements for persons age 65 or more, SIS also prevents a fund from accepting single contributions, in excess of three times the annual non-concessional contribution cap for persons under age 65, and in excess of the annual non-concessional contribution cap for persons 65 and over. Persons age 75 or over will not be able to have the overseas transfer contributed to superannuation. In determining the amount that can be accepted as a single contribution, SIS includes the entire overseas transfer amount (including the election amount), hence potentially preventing a transfer amount that is in breach of the single contribution acceptance limits. The superannuation industry believes that this outcome is unintended and legislative amendment is continued to be sought. 13

14 5 Superannuation Contribution Caps (continued) Possible strategies to avoid the problem are considered below. 5.2 Manoeuvring around the Contribution caps It may be possible to manage the transfer to avoid or reduce the impact of the contributions caps as well as the restriction on single contributions by: Using the election amount to reduce the amount counted towards the non-concessional cap, where excessive contributions tax is a concern Making transfers in instalments from the UK fund if allowable, to ensure the single contribution limits under SIS are not breached, and over two or more financial years to ensure the non-concessional contribution cap for tax purposes is not breached splitting the transfer value to several Australian QROPS, if the UK fund will allow it to overcome the SIS (but not tax) restrictions on single contributions over the non-concessional cap Transferring the full amount When calculating the impact on transferring the full balance, consider if there is an election amount. The election amount will reduce the amount counted towards the non-concessional cap and may reduce it to below the cap. If the accumulation value is still above the cap, then benefits of the transfer may still be outweighed by the potential tax. However, this will vary with each situation. The advantage is being able to transfer funds in without breaching the cap. However complications include: The overseas fund may not provide for partial transfers. Not being able to request an election on a partial transfer (even if it is an employer sponsored scheme). The tax liability on growth must be met by the client. For example some clients with large account values may consider transferring the amount of their UK benefit in excess of the relevant non-concessional contribution cap limit to another UK pension plan. This creates two distinct benefits and they can now move each UK fund in total, remain within the single contribution requirements and still have the ability to make an election. If the first UK plan qualifies as an employer-sponsored plan where the client has not been required to meet the FIF requirements in each year s Australia tax return, they will need to start doing this for the new interest in their second UK plan. These strategies are subject to the procedures and scheme rules of the UK pension scheme. While they may achieve acceptance of the full transfer amount into Australian superannuation, their may still be an excess over the non-concessional contributions cap which will still be exposed to excess contributions tax. Whilst industry is hopeful of some relaxation of the contribution cap rules generally in respect of foreign transfer amounts, management of the issues described remains critical. Transferring a partial amount This may be an option worth exploring, particularly if the client has an exceptionally large overseas fund or wishes to make other non-concessional contributions as well. 14

15 6 Other considerations While tax and superannuation caps will be the predominant considerations, there are other aspects to work through. 6.1 Income Tax Pension payments from the United Kingdom received by an Australian tax resident must be included in the recipient s assessable income. There is no tax free pension income on attaining age 60 for UK pensions payments. There are some specific exemptions such as a person holding dual residency and the pension income is being taxed in the UK or where an Australian resident is receiving pension payments that are considered exempt income such as a UK War Widows pension. (Ref ATO Interpretative Decision ID 2008/6) Article 14 of the UK Dual Tax Agreement provides that any pension derived from UK sources by an individual who is a resident of Australia shall be exempt from tax in the UK. As the taxpayer is a resident of Australia for income tax purposes, the pension income is included in the taxpayer s assessable income under section 27H of the ITAA However the taxable amount of these payments may generally be reduced by the deductible amount. (Refer ATO Taxation Determination TD 2006/54). In some instances the client may have access to a deductible amount of up to 8%. 6.2 Insurance IFSA have written to HRMC to request confirmation that insurance premiums can be charged to an individual s Australian superannuation account which contains QROPS money without these payments being regarded as unauthorised payments. HMRC has not yet expressed an opinion on this matter. 6.3 Centrelink An Australian retirement fund will count towards both the income and assets test for Centrelink means testing. However a client drawing an income from pension phase is eligible for the Centrelink deductible amount. Where the client is drawing a pension from the UK, the income is counted for the income test however there is no deductible amount. The UK fund does not count towards the assets test. 6.4 Family law splits Once a UK fund is transferred to an Australian fund, it can become part of a Family Law split. If the split is within 5 years of the client having become a non-resident of the UK, then the split can only go to another QROPS without being treated as an unauthorised payment for UK purposes, yet the non-member spouse has an unfettered right to nominate what Australian fund it is paid to. 6.5 Death Benefits payments Where the member has not met the 5 year rule, paying funds to a death benefit beneficiary either as a lump sum or a pension falls within the QROPS reporting to HRMC requirements. A QROPS must report all death benefit payments. Upon the death of a member with QROPS money, all the requirements for death benefits in the UK are subject to Sections 168 and 169 of the UK Finance Act These sections have 6 rules for pension benefits and 9 rules for lump sum benefits which allow death benefits to be classified in the UK as an authorised payment. Authorised payments for the death of a member are payments made under the Life Time Allowance (LTA) currently 1.65m (2008/09) which is roughly AUS$3.5m to a dependant of a member. 15