How the 25% tax-free pension lump sum works in Spain

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.

One of the great benefits of living in the UK is that an individual can access their pension benefits from age 55 and withdraw up to 25% as a tax-free lump sum (in 2023-24). However, what happens if you move abroad? Do you still enjoy the same tax benefits?

At Scottsdale, we advise UK clients in Murcia, Alicante and other parts of Spain on questions such as these. Below, our financial planners offer a short guide to taking pension benefits as a British expat living here. We hope these insights are helpful to you.

If you want to discuss your financial plan or pension with us, please get in touch to arrange a no-obligation financial consultation, at our expense:

+34 966 460 407
info@scottsdale.eu

The tax-free lump sum: a short guide

There are different types of UK pension and not all of them follow the same rules. The State Pension, for instance, is an income provided by the British government – with the amount based on your National Insurance (NI) record. This pension cannot be taken as a tax-free lump sum, but continues indefinitely until your death after you start claiming it.

Similarly, a “final salary” (or “defined benefit”) pension provides a retirement income from your former employer – such as the Teachers’ Pension. For all of the pensions mentioned so far, there is no “pot” of money which can be accessed and withdrawn.

The 25% tax-free lump sum, therefore, primarily concerns UK-based “defined contribution” pensions. These schemes typically involve building up a fund by making monthly pension contributions, often with an employer also contributing. When an individual turns age 55, he/she can usually then withdraw up to 25% of the value in their pension pot(s) without income tax.

Once the 25% threshold is exceeded, however, the taxpayer’s marginal rate applies. In 2023-24, a UK tax resident can earn up to £12,570 without paying income tax. Any pension income above that will be taxed at the basic, higher or additional rate(s).

The tax-free lump sum an British expats

The above rules assume that the pension scheme member lives in the UK. Yet what about British expats based in Spain or elsewhere overseas? Here, the main issue is the individual’s tax residency. If you are still deemed a UK tax resident when taking pension benefits, then you can still qualify to withdraw your tax-free 25% lump sum.

If you are regarded as a Spanish resident (for tax purposes), however, then your pension will be subject to Spanish income tax. In 2023-24, there is currently no tax-free pension lump sum similar to UK rules. Therefore, if you are thinking about retiring to Spain and have not yet moved, it may be worth speaking with a financial adviser beforehand to ensure that you withdraw pension benefits in the most tax-efficient way.

The UK has a double taxation agreement with Spain, so you should not be taxed twice (by both countries) on the same pension income. It is your responsibility to notify the relevant tax authorities – such as HMRC – of your tax residency status. HMRC should then inform your pension provider about your circumstances. However, it is always worth checking directly with your scheme administrators to ensure they have been notified.

What to do with the 25% lump sum?

An individual may be able to take 25% of their pension as a tax-free lump sum, but that does not mean that they necessarily should. The first issue to consider on this subject is sustainability. Taking 25% of your pension likely represents a large sum and could lower your income later in retirement. In worst cases, taking too much out of your pension can even lead to running out of money. Consider seeking financial advice, therefore, to ensure that any pension withdrawals are both tax-efficient and sustainable.

Assuming that taking your 25% tax-free lump sum is a good idea, what should you use it for? There can be many options depending on your financial goals and circumstances. For a British expat retiring to Spain, the money could be valuable in helping to establish your new life overseas. Others may want to pay down their mortgage or settle it completely.

Remember, you do not need to take all of your 25% tax-free lump sum in one go. A series of lump sums can be withdrawn over time. Each withdrawal from a UK pension scheme is tested against your remaining tax-free allowance. For a UK tax resident, this can be a useful way to spread out the money across multiple tax years (to mitigate their income tax liability). However, for British expats in Spain, it may be more difficult to follow this approach if you are likely to become a Spanish tax resident (at which point, you become subject to Spanish income tax).

Invitation

If you are interested in discussing your own financial plan or inheritance tax strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:

+34 966 460 407
info@scottsdale.eu

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