If you or your employer have contributed to a UK pension while you have been working overseas, then you may be eligible for an enhancement which could cut the amount of tax that you have to pay when you start drawing your pension.
It is known as the “non-residence enhancement factor” and it reduces the potential Lifetime Allowance charge that you might face.
What is the Lifetime Allowance?
UK pension schemes enjoy an advantageous tax status. Tax relief, for example, is received on personal contributions at an individual’s highest marginal tax rate.
As a result, the UK government has taken steps to limit the pension benefits that can be accrued. There have always been limits on pension contribution levels and in 2006, the Lifetime Allowance (LTA) was introduced.
The LTA is the amount that can be taken from a UK pension (defined benefit or defined contribution) as income or as a lump sum, without triggering an additional tax charge.
Currently, the LTA is £1,073,100 (frozen at this level until April 2026).
The tax charge on amounts in excess of the LTA varies depending on whether the pension money is taken as income or as a lump sum.
If it is taken as a lump sum, then any amount over the LTA is taxed at 55% (this will usually be deducted automatically by the pension scheme administrator and paid to HMRC).
If it is taken as income, then any amount over the LTA will be taxed at 25% in addition to any regular income tax that would be due.
What is the non-residence enhancement factor?
The non-residence enhancement factor (also known as the “non-resident factor”) is not well known and is all too often overlooked by financial advisers.
It was introduced to compensate those who are contributing to a UK pension scheme while working and being tax resident overseas.
As a result of living overseas, typically we don’t have access to UK tax relief on pension contributions, as we pay income tax in a different country.
Therefore it would be unfair to apply the LTA to our pension savings which are accumulated while overseas.
The enhancement factor effectively increases an individuals LTA above the standard level to take account for non-tax-relieved pension contributions
Who can apply for an enhanced LTA?
The non-residence enhancement factor is available to those who, after 5th April 2006, have been a ‘relevant overseas individual’ at any point during the active membership period of a registered pension scheme.
This typically happens when you work for a British company (or their subsidiary or related party) outside the UK.
Who is a relevant overseas individual?
Section 221(3) Finance Act 2004 states a relevant overseas individual is someone who either:
- Is not a relevant UK individual under section 189 Finance Act 2004 – meaning they don’t meet the definition in PTM044100 or
- Is a relevant UK individual in only the following specified circumstance:
- They are only a relevant UK individual because of the five-year rule in section 189(1)(c) Finance Act 2004, that is the third bullet point in the definition of a relevant UK individual linked above, and
- They are not employed by a UK tax resident employer.
It would be possible to be a relevant overseas individual on more than one occasion during the active membership of a scheme.
For example, you could be overseas for 3 years, return to the UK for 2 years and then be overseas again for 4 years. In these circumstances, the aggregate of the two non-residence factors calculated would be applied.
Examples of the non-residence enhancement factor
Defined benefit pension
Mike began working overseas on 6 December 2009 and he became a relevant overseas individual on 6 April 2010.
Mike’s pension entitlement as of 6 April 2010 was £30,000 per annum.
Step 1 – £30,000 * 20 = £600,000
Having completed assignments in Poland and Malaysia, Mike returned to work in the UK on 9th August 2019 and he ceased to be a relevant overseas individual on 5 April 2019.
This date was before any benefit crystallisation event and before he ceased to accrue benefits under the defined benefits arrangement.
His pension entitlement as of 5 April 2019 was £50,500 per annum.
Step 2 – £50,500 * 20 = £1,010,000
Step 3 – £1,010,000 – £600,000 = £410,000
Mike’s defined benefits arrangement non-residence factor is therefore 0.40. That is calculated by dividing £410,000 by £1,030,000 (the standard lifetime allowance for the 2018-2019 tax year).
Step 4 – £330,000/£1,030,000 = 0.40.
This means that Mike’s enhanced LTA for the current tax year (2021/2022) will be £1,502,300 – the standard LTA of £1,073,100 plus the enhancement factor.
Step 5 – £1,073,100 + (£1,073,100 * 0.40) = £1,502,300.
Step 6 – Potential tax saving = £1,502,300 – £1,073,100 * 25% = £107,300
Defined contribution pension
Sue began to accrue benefits under her money purchase pension on 6 January 2009. She was transferred to work in Thailand on 12 January 2012 and so became a relevant overseas individual on 6 April 2012.
On 6 May 2019, her contract was changed to a local one and she was unable to continue contributing to her money purchase pension. Her employer also ceased contributions at this date. She, therefore, ceased to be an “active member” of the scheme on 5th April 2019.
The total contributions made by Sue and her employer between 6 April 2012 and 5 April 2019 amounted to £210,000.
Her money purchase non-residence factor is therefore 0.21.
This is calculated by dividing £210,000 by £1,030,000 (the standard lifetime allowance for the 2018-2019 tax year)
Step 1 – £210,000 / £1,030,000 = 0.21
This means that Sue’s enhanced LTA for the current tax year (2021/2022) will be £1,298,451 – the standard LTA of £1,073,100 plus the enhancement factor.
Step 2 – £1,073,100 + (£1,073,100 * 0.21) = £1,298,451.
Step 3 – Potential tax saving = £1,298,451 – £1,073,100 * 25% = £56,337.75
How do I claim my enhanced LTA?
Obtaining this entitlement is not automatic. You must notify HMRC using form APSS 202.
Applications for the non-residence enhancement factor must be made either;
1) no later than five years after 31st January following the end of the tax year in which the “accrual period” ends.
For example, if the accrual period ended in November 2015, the application would need to be received by 31st January 2020
The “accrual period” ends when the earliest of the following events occurs:
- immediately before a benefit crystallisation event in relation to the individual’s arrangement
- the individual ceases to be a relevant overseas individual, and
- benefits cease to accrue to or in respect of the individual under the arrangement.
2) five years from the end of the tax year in which you return to the UK.
For example, if someone returned on 1 February 2016, they must claim the enhancement by 5 April 2021.
If you have spent a substantial amount of time outside the UK and contributed to a pension during that time, you might be able to have your LTA increased, thus saving a lot of money on the related tax charge
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