Taking benefits from UK defined contribution pension schemes

February 6, 2024

Looks at the tax differences between taking UK pension benefits or transferring to NZ and taking NZ pension benefits.

UK Pension benefits

I am often asked about the relative benefits of taking pension benefits directly from a UK defined contribution pension scheme versus transferring them to a New Zealand QROPS (Qualifying Recognised Overseas Pension Scheme) and then taking benefits from the New Zealand pension scheme. I can only advise on the tax side of such a question and the tax answer may be persuasive, but must be put in the context of overall financial advice. Financial advice in New Zealand can only be provided by an authorized financial advice provider, and it is recommended that individuals consider seeking this.

What is a defined contribution pension scheme?

A defined contribution scheme, sometimes called money purchase scheme, is one where the pension benefits are almost wholly determined by the level of pension contributions from the member and their employer and the investment performance of the funds over time.

What kind of benefits can be taken from UK defined contribution pension schemes?

Benefits from defined contribution schemes can generally be taken as:

An initial lump sum (often called the 25% tax-free lump sum)
A purchased lifetime annuity
Drawdown benefits

What is the UK tax treatment for a New Zealand tax resident?

Although UK pension benefits paid to a New Zealand resident are exempt from UK tax under our countries' double taxation agreement, the UK PAYE system will apply at rates of up to 45% unless relief is applied for and granted. It can take up to 12 months for such relief to be granted, so the real choice is between applying for relief and waiting, or take benefits and applying for a refund, which can also take up to 12 months to be processed. It is possible to complete UK tax returns to get are fund, but that usually has a financial cost and can only be done after the end of the tax year in which the benefits are taken, and PAYE tax has been deducted.

What is the New Zealand tax treatment of benefits taken from a UK pension scheme?

It is important to make clear at the outset that what the UK consider to be tax-free and taxable elements of pension benefits has no relevance to New Zealand tax rules.

Lump sums may be partially or fully taxed under the New Zealand tax rules under the Schedule or Formula methods of calculating taxable income. These calculation methods may be simple to apply for most individuals but can be very complex for some.

In general, pension income is fully taxable in New Zealand, and the income from a purchased lifetime annuity would fall into this category. However, there may be some uncertainty whether a series of lump sums taken from a UK pension scheme in drawdown is fully taxable pension income or partially taxable lump sum withdrawals.

Another very important point is that New Zealand does not permit any UK tax deducted from UK pension benefits to be claimed as a credit against a person's New Zealand tax liability.

Transfers of pension funds to QROPS

The transfers of a whole UK pension fund to a New Zealand QROPS will come within the New Zealand rules for lump sum withdrawals from foreign superannuation schemes. The Schedule or Formula methods of calculating taxable income apply to the lump sum to determine any taxable element.

What is significant is that no UK PAYE will have been deducted from the transferred amount, so there is no protracted repayment process to go through.

If you use a financial adviser to transfer your fund there may be charges involved, and there may be charges levied by the scheme if you try to make a full withdrawal within a certain period of time, usually 2 or 3 years.

The main differences

The main differences can be summarized as follows:

Taking benefits from the UK pension scheme:

o May involve the temporary loss of significant amounts to UK PAYE which must then be claimed back

o Will avoid any transfer fees

o Will avoid any early withdrawal fees

o Will involve the calculation of taxable income under New Zealand tax rules, with some uncertainty possible if benefits are taken over a number of years.