Bringing your UK pension home: “Scheme Pays” now in force

By Angus Isherwood & Kirsty Hallett

An amendment to the pension transfer regulations enacted in the Taxation (Annual Rates for 2024−25, Emergency Response, and Remedial Measures) Act is now in force and will reduce friction for New Zealanders returning from the United Kingdom (UK) and new migrants who are bringing their pension with them. The change will make it easier for New Zealanders to settle their tax liabilities without the potential of suffering from hefty UK tax charges.

Inland Revenue’s hope is that the change will reduce barriers to transfers and encourage investment into New Zealand capital markets. However, the change will also produce a new set of pitfalls (discussed below) that savers need to be aware of. While the legislation introducing the changes has been enacted, we are still waiting on further guidance from Inland Revenue on the practical implications of the changes.

For more information on pre-existing challenges that may arise from transferring a UK pension, please refer to our June 2024 Tax Alert article.

The Catch-22 of settling NZ tax debt

The clashing rules governing taxation of pension schemes in New Zealand and the UK have long made it difficult for returning ex-pats and new migrants from the UK to transfer their pension to New Zealand without incurring a substantial tax liability. A taxpayer has a four-year window in which they can transfer their pension from the UK to a New Zealand Superannuation scheme tax-free (and later withdraw it tax-free too). Any amounts transferred outside of this four-year exemption period will give rise to a New Zealand tax liability calculated with reference to the individual’s personal marginal income tax rate (up to 39%).

Historically, a New Zealander in such a situation could not have the tax payable deducted directly from their transferred funds. That tax could be a substantial amount if the individual transfers a large pension fund many years after becoming New Zealand resident. This, combined with UK pension rules that prevent premature withdrawals from pension funds (non-complying withdrawals can be charged at a rate of up to 55%) results in a Catch-22 where a transferee wishing to settle their New Zealand tax liability by withdrawing some of their pension cannot do so because of the exorbitant penalties that the HMRC would impose.

The (imperfect) solution: Make the scheme pay

The rules now allow a person transferring their overseas pension to a New Zealand superannuation scheme the choice of having the scheme deduct the tax payable on their behalf, effective from 1 April 2026 known as “scheme pays". Where scheme pays is elected, the scheme will deduct a Transfer Scheme Withholding Tax (TSWT) at a flat rate of 28%. The TSWT is a final tax, meaning there will be no further tax payable (or refundable) regardless of the person’s own marginal income tax rate. Notably, TSWT will only apply to transfers to a New Zealand superannuation scheme; lump sum withdrawals and pensions derived from an overseas pension scheme will continue to be taxed at the personal marginal income tax rates.

Significantly, the mechanics of scheme pays have been purposely designed to enable the individual to clear their New Zealand tax liability using the funds transferred without breaching UK pension restrictions and triggering a UK tax charge.

However, while scheme pays addresses the core concerns and should simplify the pension transfer landscape, there are still some complexities to be mindful of:

• Scheme pays is optional. It is the person making the pension transfer’s choice whether to elect into scheme pays. The election is made at the time of making the transfer. However, once the election is made it is irrevocable.
• TSWT will be set at a flat rate of 28%. This will be a final tax, regardless of the individual’s own personal marginal income tax rate. Making a pension transfer can push you into a higher tax bracket (e.g. 17.5% to 30%) so the decision whether to elect for “scheme pays” may not be as obvious as first thought.
• If an individual’s marginal tax rate (after taking into account the transfer) is below 28%, then they will pay excess tax under scheme pays on the transfer which cannot be refunded.
• It is the individual’s responsibility to provide the New Zealand scheme provider with the correct transfer information including determining the taxable amount of the transfer within ten working days of their scheme receiving the foreign pension funds. If the scheme provider is incorrectly advised of the taxable amount, any shortfall of tax will need to be funded by the individual from other income sources (i.e. you will not be able to settle the additional tax due by making a further deduction from the funds transferred). Further, as TSWT will be a final tax, any overpayment of tax will not be refundable. The rules for calculating the taxable amount of a pension transfer can be complex so care will need to be taken to ensure this is calculated correctly to avoid any unexpected tax bills down the track.
• While QROPS (Qualifying Recognised Overseas Pension) schemes are required to offer scheme pays, KiwiSaver providers are not required to offer scheme pays services for their customers - it is worth checking whether yours does before proceeding with a transfer.
  

Increased Inland Revenue Visibility

It is also worth noting that a further change enacted in the Act will re-classify transfers from overseas pension schemes to New Zealand schemes as “investment income”. This will apply regardless of whether a person has elected for scheme pays and requires scheme providers to submit monthly reports of transfers they have received to Inland Revenue.

This means Inland Revenue will now be notified by the New Zealand scheme providers of the transfers they are receiving. The increased visibility Inland Revenue will have, and the risk of future audits further elevates the importance of correctly determining the correct amount of assessable income when making a transfer.

I need help, what can I do?

Transferring your pension fund can have consequences far beyond those discussed here. You need to consider your future needs, compare your expected returns from re-investing, and your potential exposure to various asset classes and currencies before making any big decisions. A financial advisor can help you to navigate the complexities of your personal situation, please note Deloitte is not a registered financial advisor.

If you are considering transferring or withdrawing your UK or overseas pension entitlements and have questions about the tax implications could mean for you, please contact your usual Deloitte advisor.