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Expat Briefing Editorial Team, 25 October, 2013
Financially, expatriates could be said to be in a uniquely privileged position – if a company chooses to send an employee overseas, it will usually compensate them with higher wages, expenses, and other perks. Expats may also find themselves with greater freedom when it comes to making investment decisions, as they are not usually caught in a restrictive regulatory net in the same way that domestic investors tend to be. However, every silver lining has a cloud, and that cloud, for many expatriates, is retirement planning.
Why should this be the case? Well although pension investment is usually tax-privileged in high tax countries, internationally mobile professionals may find themselves unable to take advantage of this due to the peculiarities of the expatriate lifestyle. If you have a domestic pension plan in place prior to expatriation, you may find out after the event that it is not as mobile as you are. For instance in the UK, where the government has recently relaxed its position on pension transfers overseas (see the notes on QROPS below), if you belong to a stakeholder scheme and become non-resident, you can only continue to contribute for a maximum of five years. While admittedly this is an improvement on the previous limit of two years, it is still likely to cause fragmentation for those not planning to return to the UK.
Switching from plan to plan as you change host country doesn't always make a great deal of sense either, and can mean that the income you end up with in later life is fragmented, and whittled away by foreign exchange costs or cash-strapped governments.
Apart from the European Union there is no international organization with the power or the desire to ease cross-border transfers of occupational (ie non-State) pensions. As regards State pensions, which for many expats are so small as to be trivial, there is a growing number of country pairs which have reciprocal arrangements for payment of acquired pension rights. These are sometimes embedded in Double Tax Treaties, and sometimes covered by separate agreements; for instance, there is a Totalization Agreement between the US and Canada. Usually such agreements apply across a range of social security benefits, and cover contributions as well as benefits. But of course they don't extend to private or occupational pensions schemes.
Pensions In the European Union
The EU's equivalent of a totalization agreement is known as EULISSES as regards State pensions. But for most expats, occupational pension schemes are a much greater preoccupation.
The European Commission announced grandly in October 2005 that workers switching jobs or countries would no longer have to worry about substantial loss of work pension benefits under the 'portability of pensions' Directive that it had proposed. Previously, changing job or country could mean losing occupational pension benefits in some Member States. But the proposal announced by the EC would mean avoiding major losses, and in many cases allowing benefits to transfer with the worker across sectors and countries in the EU.
The Directive aimed to help the growing numbers of EU workers who are switching jobs, and was designed to reduce the obstacles to mobility within and between Member States caused by supplementary pension schemes provisions. These obstacles relate to: the conditions of acquisition of pension rights (such as different qualifying periods before which workers acquire rights), the conditions of preservation of dormant pension rights (such as pension rights losing value over time) and the transferability of acquired rights. The proposal also seeks to improve the information given to workers on how mobility may affect supplementary pension rights.
The proposed legislation has not however had an easy ride. After the European Parliament did considerable damage to the main planks of the Directive in 2007, the European Commission announced in October, 2007, that it had adopted an amended proposal taking on the majority of the European Parliament's amendments, focusing on the setting of minimum requirements for better access to pension rights, clearer rights of preservation so mobile workers' pensions are treated fairly, and improved access to useful and timely information. The aim of the Directive is now to ensure that workers are not penalised because of mobility rather than to enforce transferability, the original goal of the legislation.
Finally, in June 2013, the EU's Council of Employment, Social Policy, Health and Consumer Affairs agreed on the Commission’s general approach for a directive on improving portability of supplementary pension rights. The Commission says that the proposed directive constitutes “a first, but very important, step on removing obstacles to free movement relating to supplementary pensions.” However, this Directive does not cover the "portability" of supplementary pensions, i.e. the possibility of acquiring pension rights (even for shorter periods of employment than the required minimum "vesting period" or at the beginning of one's career) and keeping pension entitlements by transferring them to a new scheme in the event of professional mobility. The Council's agreement on the general approach paves the way for adoption of the Directive in the current mandate of the European Parliament.
Another EU Directive, 2003/41/EC, on the activities and supervision of Institutions for Occupational Retirement Provision, known colloquially as IORP, which attempts to create a Europe-wide market for pensions provision, is a framework directive, and fairly toothless at that - it has been left to individual countries to implement regulations under the Directive, and they have not done much. The European Commission has since announced a review of the IORP Directive which entailed a public hearing in September 2011 and the preparation of an impact assessment in advance of new proposals.
In the face of all this ineffective Eurowaffle, for the time being, therefore, hopes for a Europe-wide pensions market probably rest with the European Court of Justice, which ruled in early 2007 that Denmark was in breach of European law on freedom of movement of workers and capital by not granting tax-deductions on contributions to pension contracts with foreign insurers. That same year, the European Commission launched infringement proceedings against nine member states for taxing dividend and interest payments to foreign pension funds (outbound payments) more heavily than dividend and interest payments to domestic pension funds. Then EU Taxation and Customs Commissioner László Kovács said that the European pension industry had complained about higher taxation of pension funds if they exercised their rights under the EC Treaty to invest across the border. "The Commission is taking these complaints seriously and has decided to start formal enquiries," he added.
Under European Union (EU) law, entitlement to an old age benefit cannot be conditional on the pensioner living in the member state where he or she claims the benefit. Additionally, EU law on the free movement of persons stipulates that member states should not introduce discriminatory policies regarding where a taxpayer chooses to retire whilst retaining their pension.
Multinationals' Pension Schemes
Sometimes, an international company will offer a pension plan to expatriate employees as part of their benefits package, but sadly this is nowhere near as common as it used to be. In what are, after all, fairly lean times, many companies seem to feel that it is not cost effective to offer decent benefits packages to more junior expatriates, and are more likely to concentrate on immediate benefits such as increased wages. So unless your employer is considerate enough to provide you with a benefits package tailored to suit your needs, the onus is on you as an individual to provide for your own retirement, even if your employer makes a financial contribution.
Several international pension providers also offer corporate pension schemes, for the aforementioned lucky souls whose employers are enlightened enough to offer retirement benefits as part of their expatriation package. These can usually be tailored to suit each expatriate employee, wherever they are based, and whatever their responsibilities within the company. For employees, they usually provide similar advantages and benefits as personal international pension plans, but they sometimes differ in that an optional vesting period can be set up by the company to encourage employee loyalty. This basically means that any contributions by the employer remain the company's property for a given number of years. However, the suitability of vesting periods will depend on the tax position taken on this issue by the company's country of origin.
Private International Pensions Provision
As we have seen, moving a pension across a national border can at best add a further layer of complication, and at worst be downright impossible. So what are you to do? The most sensible solution would seem to be to find a safe place to anchor your retirement savings and/or investments so that you can move from country to country if necessary, without this having any negative impact on your assets; but if you decide to do this, you need to decide exactly where that safe place should be. Offshore financial centres may present a viable alternative, especially if you are undecided as to your eventual retirement destination, as basing pension investment offshore should mean that future movement of capital or income is not impeded. (Although pension funds in 'offshore' or 'low-tax' jurisdictions will grow partly or completely without taxation, and may have been established out of tax-free income in the first place, any retirement income eventually received in a high tax country will obviously be liable for taxation.)
Unfortunately, however, once again, US expatriates and other expats that have been relocated to the States are unable to fully take advantage of international retirement planning options in the same way as other expats, due to the punitive US taxation regime. Offshore providers view dealing with American clients as something of a minefield, although some IFAs will continue to deal with clients who have moved there, and should be able to advise on an appropriate course of action.
Offshore pensions providers, like birds of a feather, have tended to flock together in well-regulated jurisdictions with stringent investor protection legislation, such as Jersey, Guernsey, and the Isle of Man. As a result, these jurisdictions have developed responsive regulatory regimes and highly efficient business infrastructures. Dublin and Luxembourg have also come into favour as offshore locations from which to offer pensions, but these products are usually more specific to a European audience.
In the last few years, some of these jurisdictions have begun to offer QROPS to British expats in particular. If a British citizen has become non-resident on a permanent basis, and has no present intention of returning to the UK, they can move their pension fund out of the UK to another country. For the first five years of non-residence, the fund will remain subject to HMRC's rules, but after that the rules that apply will be those of the destination country of the fund. Such a transferred fund is called a Qualified Recognized Overseas Pension Scheme.
Although the difficult decision regarding which offshore jurisdiction to base your investments in has to some extent been taken out of your hands, then, there still remains the question of whether you want to go for a pre-wrapped (as it were) pension plan, or put together a portfolio of suitable investments yourself (with the help of a qualified professional of course!), with a view to providing retirement income in that way. Both forms of pension investment have their advantages and their disadvantages, and in the end, which path you choose will come down to your personal circumstances and preferences.
However, there are a number of brokers (both international and jurisdiction based) and Independent Financial Advisors (IFAs) out there who specialise in retirement planning, and can make the decision easier for you, taking some of the responsibility for overall investment and tax planning off of your shoulders. They can help you to decide, given your personal circumstances and responsibilities, whether it is best to self-invest or go fully insured, how much you should be investing or saving to provide for your retirement, and if you choose to invest towards your retirement, can help you to structure your portfolio.
Putting together a managed portfolio with the help of an IFA has distinct advantages, but by the same token, distinct disadvantages. This form of retirement planning could be seen as more flexible, as the investment choices (to a certain extent) are in your hands. You can choose how varied you would like your investment instruments to be, and whether to include shorter-term investments, or savings schemes with no strings attached.
It also has the advantage that there are no penalties for reduction or discontinuance of investment if your circumstances change unexpectedly, and there are usually no limits as to the maximum or minimum investment, or the frequency of contribution. However, with this flexibility can sometimes come added risk (which is not ideal when investing for your retirement), which will necessitate more frequent checks and reviews. Therefore, you need to decide, with the help of your financial advisor or broker, whether the added flexibility is worth the potential risk and added responsibility.
Alternatively, you could opt for a ready packaged pension or retirement income plan. Many domestic insurers also offer international alternatives to domestic pension plans tailor made for expatriates, usually located in one of the offshore jurisdictions previously mentioned. Following this path will almost certainly take some of the worry and hassle out of saving for your retirement, and international pension plans are far less unwieldy than they used to be, offering greater flexibility of investment choice, and a wider range of funds than ever before. Putting your money in an international plan will also mean that you can usually invest in offshore funds at a much lower premium than you would otherwise be able to.
However, be careful not to lock into a long-term commitment if your income stream or circumstances are uncertain, as the penalties for temporary non-payment or discontinuance of premiums can be substantial. International pension plans can be accessed either through a broker or IFA, or in some cases (although not many) directly, and in making your choice, there are questions that you (or your IFA) will need to ask the provider:
What are their annual and administration charges? Are they unusually low or high compared with other insurance providers? If so, why?
Which companies have the best historical fund performance?
Which plan is best for you, and within that plan, which fund sectors are most suitable?
Are there a wide range of fund types and sectors available?
What are the limitations imposed on how and when you can take your benefits?
What are the limits on contributions and benefits?
Do they accept contributions in a range of currencies (probably an important issue for an expat), and can the account also be denominated in different currencies if necessary?
What degree of investor protection is in place?
This is obviously not a definitive list, and proper due diligence needs to be done before any decision is made. Factors shared by the majority of international and offshore pension plans, however, include portability, low tax or tax free accumulation of capital (apart from on certain investment income which may have been taxed in its country of origin), and adaptability about the form in which you choose to take your investment income on retirement. Here there are many choices to be made?.
Retirement Income Options
Most international pension providers will offer you the opportunity to take your retirement income as a cash lump sum, guaranteed annual or monthly income, or a combination of the two. Which you decide is best will probably depend on the potential tax implications for you at that time, and your intended lifestyle. However, if you decide to opt for a steady income, you must decide in advance whether you want to receive a fixed annuity, or to buy deferred income as you go along. If you feel that insurance companies will reduce annuity rates as life expectancy increases, then you may want to go for the deferred income option. However, this decision really requires a crystal ball with which to gauge the future behaviour of the pension provider, and interest rates until you retire, so we will not go into it any further here – an independent professional advisor will be more able to point you in the right direction.
After years of low interest rates, annuity rates are not wonderful, and if you are of an adventurous turn of mind, you may prefer to live directly off the income from your investments. Some brave souls who think they know how much longer they have on this earth even make their own calculation, turning their capital into a sinking fund, paying themselves each year a proportion of the capital plus the income on it, so that the money runs out (they plan) just when they depart. Just remember the story of Jean-Marie Calment, who did such a deal with her landlord (the other way around) when she was 75 and lived to be 122. He had to watch her live 'free' for 30 years more than he had bargained for.
To conclude, then, whether your employer will provide retirement benefits as part of an overall package, or whether it is up to you to make provisions for your retirement, if you're an expat, then it is probably necessary and desirable to take the international pensions option in order to avoid reduction or fragmentation of your income, and possible confusion in later life. And, whatever your eventual plans, the sooner you look into providing for your old (or middle!) age the better. Leaving your retirement planning until the last minute may mean that you are unable to provide a decent standard of living for yourself and your dependants.