Tax and pensions
By Stephen Rankine, Private Client Manager, Blevins Franks
What tax will you pay on your pensions in Portugal? Other than government service pensions, your pension income will be liable for Portuguese tax, with the treatment varying according to the type of pension. And what UK tax issues do you need to keep aware of?
We work hard to build up our pensions for a secure and enjoyable retirement; to be able to do all those things we didn’t have time for before and have peace of mind about our future. But while our pensions feel like our money, money we set aside for retirement, they are still liable to income and other taxes. And if you are living in Portugal with a UK pension, you have tax considerations in both countries.
Here I look at a few issues you need to be aware of.
How UK pension income is taxed in Portugal
Much depends on what type of pension you have and, in some cases, how the contributions were made.
UK State Pension
Once you are tax resident in Portugal, your State Pension is taxable only in Portugal at the scale rates of income tax. For 2023 income this starts at 14.5% for income up to €7,479 and rises to 48% for income over €78,834. You benefit from a deduction of up to €4,104.
Likewise, occupations pensions are generally taxed as general income in the same way as State Pensions.
In some cases, if there have been employer contributions, a more beneficial tax treatment could potentially apply (as with personal pensions) but you would need personal advice.
Government service pensions
In contrast, income from government service pensions are always liable to UK tax and are not taxed in Portugal at all.
This is where it can get confusing and depends on how you made your contributions. Portugal has a traditional view of what constitutes a pension. In the UK you can have a retirement annuity contract, a SIPP, SSAS, or defined benefit or defined contribution occupational schemes, and they are all treated as pensions for tax purposes. In Portugal, however, in order to be taxed as a pension there must be an employer contribution (since pension income is effectively deferred employment income).
Personal contributions are taxed differently than employer contributions. The capital element (the contribution) is not taxed. The growth is treated as investment income so you can opt for the fixed 28% rate.
Personal pensions without employer’s contributions can be considered a savings scheme and receive the favourable tax treatment applied to life assurance policies.
However, most UK nationals have a mix of both employer and personal contributions and cannot distinguish between the elements, so all their UK pension income is likely to be taxed at the scale rates.
Pension lump sums
This is one tax trap many Britons moving to Portugal fall into. The UK rules allow you to take a 25% ‘pension commencement lump sum’ tax free. But if you take this lump sum after becoming resident in Portugal, it is taxed here in the same way as other pension income.
Pension treatment under non-habitual residence (NHR)
If you registered as a non-habitual resident before 31 March 2020, your foreign source pension income is generally tax free.
If you are registered from April 2020 onwards, your foreign pension income is generally taxed at 10%. While no longer tax free, this is still beneficial as it is lower than the income tax rates otherwise applied and particularly favourable for those with higher pension income.
The exception is UK government service pensions, which remain taxable in the UK.
The UK has frozen income tax thresholds until 2028. Therefore, if you are paying UK income tax on your pensions, it is likely that more and more tax will be taken over the next five years.
On a positive note, however, the UK’s 2023 budget abolished the pensions lifetime allowance and resulting 25%/55% tax charges – very welcome news for those who have built up larger pension savings over decades of contributions and growth.
This is not necessarily permanent, though, as a future government could reverse this move, and the Labour Party quickly pledged to do so.
There may therefore be a limited opportunity to transfer your pension out of the UK and avoid any future lifetime allowance charges. Blevins Franks can review your funds to establish if this would be a suitable option for you.
UK tax changes ahead?
The Institute for Fiscal Studies (IFS), a UK economic think tank, has published a controversial report in December 2022 recommending that UK pensions should be liable to income and inheritance tax when the scheme member dies. Currently, pensions escape UK inheritance tax and income tax is not payable when the holder dies before age 75.
The IFS is calling for basic rate income tax to be applied to the remaining pension funds on death regardless of age – which would generate a new source of income for the government – and for the pension to be included in the value of the estate for inheritance tax purposes. It estimates that applying inheritance tax to pensions could raise £1.9 billion of revenue for the exchequer (though it does suggest this could be used to reduce the overall IHT rate from 40% to 30%).
Whether the IFS proposals are accepted or ignored, this highlights the fact there is £3 trillion sitting in UK money purchase pensions and a potential target for HM Treasury. If you have left the UK permanently, do you want to leave such a valuable asset at the mercy of the UK government? Moving your pension out the UK now could protect you from future costly tax reforms. As always, though, take regulated personalised advice to ensure you don’t put your retirement savings at risk.
Reviewing your pension arrangements
If you are a resident of Portugal and have a UK pension you do need to review your pension arrangements and establish what is best for your current and future circumstances.
Pensions are not always set in stone, like you they might benefit from moving abroad, and you need to regularly review your objectives. That could mean changing your investment profile, reassessing your risk tolerance, or developing an alternative strategy that embraces your overall financial situation.
Far too often pension decisions are taken in isolation based on options provided by UK pension companies who are oblivious to your needs and the tax implications of living in Portugal. Blevins Franks can provide integrated advice covering pensions, investing, and cross-border tax and estate planning covering both countries.
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.
Blevins Franks Wealth Management Limited (BFWML) is authorised and regulated by the Malta Financial Services Authority, registered number C 92917. Authorised to conduct investment services under the Investment Services Act and authorised to carry out insurance intermediary activities under the Insurance Distribution Act. Where advice is provided outside of Malta via the Insurance Distribution Directive or the Markets in Financial Instruments Directive II, the applicable regulatory system differs in some respects from that of Malta. BFWML also provides taxation advice; its tax advisers are fully qualified tax specialists. Blevins Franks Trustees Limited is authorised and regulated by the Malta Financial Services Authority for the administration of trusts, retirement schemes and companies. This promotion has been approved and issued by BFWML.