When it comes to the taxation of UK pension income in Portugal, the specific rules depend on the type of pension and how contributions were made.
UK State Pension
Once you become a tax resident in Portugal, your UK State Pension is only subject to taxation in Portugal, according to the progressive income tax rates. In 2023, the tax rates range from 14.5% for income up to €7,479, increasing to 48% for income exceeding €78,834. You are entitled to a deduction of up to €4,104.
Occupational Pensions
Occupational pensions are generally treated as regular income and taxed in the same way as State Pensions in Portugal.
However, in some cases where there have been employer contributions (similar to personal pensions), there may be more favourable tax treatment available. It is advisable to seek personalised advice to understand the specific implications.
Government Service Pensions
Income from government service pensions is always subject to UK tax and is not taxed in Portugal.
Personal Pensions
Taxation of personal pensions varies based on contribution methods. Portugal has specific criteria for pension classification, requiring an employer contribution. In the UK, different pension arrangements, like retirement annuity contracts, SIPPs, SSAS, defined benefit, or defined contribution schemes, are considered pensions for tax purposes. In Portugal, pensions are deemed deferred employment income.
Personal and employer contributions are taxed differently. The capital element (contribution) is untaxed, while growth is treated as investment income with a fixed 28% tax rate.
Personal pensions without employer contributions may be seen as savings schemes, receiving favourable tax treatment similar to life assurance policies.
UK nationals typically have both employer and personal contributions, making it hard to differentiate. Consequently, their entire UK pension income is likely subject to taxation based on Portugal's progressive scale rates.
Navigating Pension Lump Sums
Many British individuals who relocate to Portugal encounter a tax trap regarding pension lump sums. In the UK, individuals can receive a tax-free "pension commencement lump sum" amounting to 25%. However, if this lump sum is withdrawn after becoming a resident of Portugal, it is taxed there similarly to other pension income.
Non-Habitual Residence (NHR)
For those who registered as non-habitual residents before March 31, 2020, their foreign source pension income is typically exempt from taxation. However, for individuals registered from April 2020 onwards, foreign pension income is generally subject to a 10% tax. Although no longer tax-free, this rate remains advantageous as it is lower than the regular income tax rates and particularly beneficial for those with higher pension income. Notably, UK government service pensions continue to be taxable in the UK.
UK Taxation Factors
The UK has maintained frozen income tax thresholds until 2028, meaning that individuals paying UK income tax on their pensions may experience an increase in tax over the next five years. On a positive note, the 2023 UK budget eliminated the lifetime allowance for pensions and the resulting 25%/55% tax charges. This change is particularly welcome news for individuals who have accumulated substantial pension savings over many years. However, it is important to note that this alteration may not be permanent, as a future government could reverse it, with the Labour Party expressing their intention to do so.
Consequently, there may be a limited opportunity to transfer your pension out of the UK and avoid potential future lifetime allowance charges. Blacktower can assess your funds and determine if this option would be suitable for your circumstances.
Expected Changes In UK Tax
In December 2022, the UK's Institute for Fiscal Studies (IFS) suggested that UK pensions should be subject to income and inheritance tax upon the death of the scheme member. Currently, pensions are exempt from inheritance tax, and no income tax is payable if the pension holder passes away before the age of 75.
The IFS proposes applying basic rate income tax to the remaining pension funds upon death, regardless of age, creating a new revenue source for the government. They also suggest including pensions in the estate value for inheritance tax purposes. The IFS estimates that implementing inheritance tax on pensions could generate £1.9 billion in revenue for the government. However, they also propose reducing the overall inheritance tax rate from 40% to 30% using this additional revenue.
These proposals highlight the significant amount of approximately £3 trillion held in UK money purchase pensions, making it a potential target for the HM Treasury. If you have permanently left the UK, you might want to consider transferring your pension out of the country to protect it from potential future tax reforms. It is essential to seek regulated personalised advice to ensure the safeguarding of your retirement savings.
Reviewing Pension Arrangements
If you live in Portugal and have a UK pension, it's important to review your pension arrangements. Assessing your options is crucial for your current and future situation.
Pension plans can be adjusted when moving abroad, so regularly evaluating your objectives is essential. This may involve modifying investments, re-evaluating risk tolerance, or developing an alternative strategy based on your overall financial situation.
Unfortunately, pension decisions are often made without considering your specific needs or the tax implications of living in Portugal. Blacktower provides comprehensive advice and solutions on pensions, investments, cross-border tax, and estate planning, taking into account the circumstances of both countries.
For more information contact Blacktower Financial Management on +351 725 566 190
This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, they are subject to change and we are not responsible for any errors or omissions.