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International Pensions

by Jeremy Hetherington-Gore, January 2006

IMPORTANT WARNING: The contents of this report have been compiled in good faith by Investorsoffshore.com to provide assistance to investors, but do not constitute investment advice or recommendations. Investors should not rely upon the information given in order to choose types or routes of investment but should make their own independent enquiries before making choices. Investorsoffshore.com has taken reasonable care in researching and presenting the information herein but makes no representations as to its accuracy and accepts no liability for actions taken or not taken as a result.

This Investors Offshore special report examines the problem of pension provision for expatriates and international executives. National schemes and company schemes typically cause more problems than they solve for such people.

Introduction

Considerations affecting retirement provision

When do you intend to retire?

Where are you going to retire to?

What form and amount of income do you want to have in retirement?

Are you confident of a regular income throughout your working life or do you anticipate that your earnings will fluctuate considerably?

Are you going to work in the same country for the remainder of your working life or are you going to be in a number of as yet unspecified countries?

Some of these questions can be impossible to answer. For instance at the age of 30 one country may appear an idyllic potential final place in the sun. However thirty years later your expectations and views may well have changed, and the country in question may be very different. Few people can have any degree of certainty about the path that their working life will take.

The idea of a job for life with the same employer is now almost completely redundant. Working in different countries for a significant period of time is an increasingly common experience for many and may be the reason that you are reading this piece in the first place. However if you are going to make adequate provision outside your current home country, then it will aid your decision making process if you can identify answers to some or all of these questions.

When do you intend to retire? At 60? At 50? The target date for your retirement and the amount of income that you would like to receive will have an impact of how much you need to save. Inflation and fate will have an impact on the eventual accuracy of these estimations but they still need to be done so that your expectations are realistic.

Where are you going to retire to? If you have identified your perfect retirement beach, then the location of your pension funds may be affected by the eventual ease of transfer of funds to such a place. If you are unable to identify a perfect location then it is worthwhile to identify the characteristics of the ideal location (as well as a suitable climate and political environment) again in terms of the local taxes and the ease of money transfer. This may have an impact on your choice of location for your pension funds.

Are you confident of a regular income? Some people work in professions in which they will probably have a regular monthly income. Other work in a more haphazard environment (entertainers, sports-people, entrepreneurs) where income may be more variable. The likely pattern of income should affect the choice of pension instrument.

Pension Portability

Individuals who work or live in a number of countries are faced with a complex situation and one that is continually changing as legislation and commercial products evolve in response to each other.

Although EU legislation exists covering the transfer of state (statutory) pensions within the EU, this is typically difficult to achieve. Transfer between state pension schemes into or out of the EU or between other countries is generally not possible.

The European Commission announced in October 2005 that workers switching jobs or countries will no longer have to worry about substantial loss of work pension benefits under the 'portability of pensions' Directive that it has proposed.

At present, changing job or country can mean losing occupational pension benefits in some Member States. But the proposal announced in October 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 will help the growing numbers of EU workers who are switching jobs, and is designed to support the Commission's 'Jobs and Growth' strategy by making it easier for workers to move jobs and countries, but it will do little to help people outside the EU or even those inside it with above average incomes.

Vladimír Špidla, European Commissioner for Employment, Social Affairs and Equal Opportunities, explained that the adoption of the proposal was coming shortly before the beginning of the 2006 European Year of Workers' Mobility.

"If we expect workers to be mobile and flexible we cannot punish them if they change jobs. Pension rights must be fully transferable. This directive has been long overdue.”

The proposal was designed to reduce the obstacles to mobility within and between Member States caused by present 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.

Once signed into law, a regular review will take place to see how the Directive's provisions are working.

The Directive does not deal with tax or indexation of pension issues.

Private Pension Schemes

State schemes, even at their most generous, and many company schemes will not provide travelling executives or expatriates with more than a minor supplement to an adequate retirement package. In many cases, companies are however prepared to pay into private schemes set up by individuals, or may even help with the setting-up of such schemes.

An individual, private scheme, whether or not supported by an employer, is therefore a necessity for most executives and expatriates. Given the uncertainty over future working and living locations, a retirement scheme will ideally be located in a low-tax jurisdiction and will not be subject to significant taxation either in terms of contributions or in terms of pay-outs. This effectively rules out most high-tax countries.

In addition, individual private pension schemes obtained from commercial providers in high-tax countries are normally very specific to those countries, and are not at all flexible if the beneficiary later needs to move a pension or a pension fund. Many companies impose severe penalties or charges on such transfers.

Many insurance companies and pension providers recognize this, and offer highly flexible schemes suitable for expatriates and executives from subsidiaries in low-tax jurisdictions such as the Isle of Man and Gibraltar. 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 any retirement income received in a high tax country will obviously be liable for taxation.)

Unfortunately, however, 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.

The Mechanics of Pension Provision

This section first identifies the various means of pension provision. These are taken to be instruments that will provide income to live on in retirement and some of these are ordinary investment methods with no specific pension association. In section 1.4 below there is a brief outline of the options at the time of retirement in terms of how you choose to receive that income.

1.1 National Pensions

Type Description Comments
Basic Countries in the developed world typically provide some form of retirement pension to those defined as eligible. These schemes are typically called state pensions.
Additional contributions Some countries allow individuals to make additional contributions to the basic state pension scheme  

1.2 Company Schemes

These are also called Occupational Pensions

Type Description Comments
Final Salary Schemes These offer a guaranteed pension amount based on the salary at retirement and the length of time served with an employer. Also known as Defined Benefit schemes
Money Purchase Schemes Contributions are invested and the final pension is based on the performance of the fund. Also known as Defined Contribution schemes.

In some cases national legislation requires the pension fund to be held separately from the main company funds and these are described as being fully-funded. National rules and individual schemes vary greatly as to the ease of preserving pension rights or transferring those rights to other schemes. There are often penalties or costs involved in such transactions. A recently tabled EU Directive attempts to rationalise such matters within the European Community but this has not yet been approved, and there will be 10 year exemptions in some cases e.g. Germany for some company schemes that are not fully funded.

1.3 Individual Pensions

For individuals who decide to create a pension in addition to any national or company provision there are a number of different options and generally these can be used in almost any combination. One major choice is between using commercial pension instruments or doing it yourself - or doing both. This choice will be affected by the availability or otherwise of suitable pension schemes in your chosen jurisdiction.

1.3.1 Commercial pension providers

Insurance companies typically offer a range of products which will appeal to different individuals according to individual circumstances including fund location, type of investment and thus the level of risk or certainty, the manner of receipt of funds on completion or termination, and the necessary timescale. Independent professional advice is strongly recommended before making any commitment.

1.3.2 DIY

The do-it-yourself approach has many different possibilities and the choices include how you own the assets and just what those assets are. The general assumption is that you are working (or at least earning) in a low-tax environment so that monies can be put into a pensions investment on a more or less tax-free basis. Although high-tax countries often allow pensions investments to be tax-free when they are made (up to certain limits), the downside is that the income is likely to be taxed when it is taken after retirement, and it can be problematic, to put it mildly, to move the income-earning assets out of the high-tax jurisdiction when retirement takes place without incurring a savage tax penalty.

Ownership of the assets can be approached in a variety of ways depending upon the local tax environment. Direct ownership by yourself is possible may not be the most tax-efficient option, especially for individuals who are or may become resident or domiciled in jurisdictions which tax world-wide income and wealth (most high-tax countries, in other words).

Type Description
Offshore Trust


An offshore trust can be set up by an expat to serve the same basic purposes as an offshore company, namely confidentiality, tax minimisation, asset protection, and estate planning. The principal difference between the two structures is that with an offshore company, ownership is maintained, whereas with an offshore trust, ownership is transferred. This has the effect of creating more distance between you and your wealth, so that it's harder for creditors, the taxman or your ex-spouse to get at it! Trusts used to be primarily aimed at tax avoidance, but in recent years the tax authorities in many high-tax countries have passed 'anti-avoidance' legislation that lets them attack trust assets while you are alive, although they are still effective against inheritance taxes.

Trust assets won't be taken into account during the probate process, so that the death of the settlor does not affect the administration of the trust, which still remains under the custodianship of the trustees. This also allows a settlor to maintain confidentiality over the size of the estate, and avoid the delays and possible publicity which would come as the result of a lengthy probate procedure, not to mention the saving on inheritance tax. Trust assets will remain in the trust for as long as the original Trust Deed prescribed (in perpetuity, if necessary, or for lesser periods), or until the terms of the trust permit or require the Trustees to distribute them. Another area in which the use of trusts is growing is asset protection, so if you have a fairly substantial liquid net worth that you would like to protect, before, during, and after your expatriation, an offshore trust may be the way to go. A basic trust structure consists of three entities; the settlor, who sets up the trust, the trustee, who acts as custodian, and the beneficiary/ies, who can receive income from it.

 

Offshore holding company


This can be used to hold investment portfolios, and is useful in providing enhanced privacy. It can be particularly useful in some offshore jurisdictions if you want to become locally resident, and need not to receive income yourself, although you may have a problem with ownership restrictions on residents. (This leads people to set up strings of holding companies in different jurisdictions). If the income of a holding company is used to make further investments, it may be that you won't be taxed on it even if you return to a high-tax domicile.

 

Offshore personal service company


If you are engaged in providing a personal or professional service, you may be able to achieve considerable tax savings, as you can contract to supply the service regardless of residence, and the fees earned can accumulate offshore while you work for a low salary in the country where you are taxed. It only works in some countries, and you may have to do something more complicated than just owning the company yourself, if it is not to be 'looked through' by the taxman.

 

Any form of investment can be used to contribute to a pension albeit without the tax benefits associated with specific pension schemes. The different forms of potential asset are almost unlimited and the following can only be indicative.

Type Description
Pre-packaged pension scheme


Choosing a ready-packaged pension plan will naturally take a lot of the worry and hassle out of the equation, as your investments will effectively be managed for you. On the other hand, locking your money into such a scheme on a long term basis means you lose some flexibility if your circumstances - income, place of residence employment, etc - happen to change, and penalties are likely to be incurred if you do not stick to the payment schedule or cease contributions altogether.

Usually a pre-packaged scheme means what is termed an 'insured' scheme, ie that it is provided by a large insurance company through an offshore subsidiary, and you can usually choose the types of underlying investment in the sense that the provider will offer a range of investment funds - based on equity, cash, real estate etc - as is the case onshore.

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 are also coming into favour as offshore locations from which to offer pensions, but these products are usually more specific to a European audience.


Direct fund investment


Direct ownership of fund units is an alternative to an insured scheme, although obviously riskier, and can make use of the same offshore jurisdictions as are inhabited by the insured scheme providers. Some of these jurisdictions have installed legislation tailored specifically to the needs of expatriates, notably the Isle of Man.

The major benefit of direct investment (direct means not through a pensions provider, but still may involve the intermediate use of a company or trust, see above) is flexibility. Also, you avoid provider and broker costs, but in exchange you may have a heavy time overhead and there are plenty of traps for the inexperienced. All in all, it may be better not to go it alone unless you are quite savvy and have time on your hands.

 

Private funds


Suitable for those expats with a longer term investment horizon, and more capital (usually not less than $1,000,000, although individual investments may be as little as $50,000). These are usually closed-end funds, involving up to 50 investors, and often generate greater returns than public funds. Quite often they would use a 'see-through' or 'tick-the-box' structure known as a Limited Partnership which allows residents of higher-taxed countries (eg the US) to repatriate untaxed profits to offset against losses or expenses at home.

A large number of offshore jurisdictions offer regimes suitable for private investment funds.

 

Share equity


Equity investment used to mean investing in securities listed on your local stock exchange to the exclusion of foreign stocks, but of recent years, all this has changed. There is a growing number of stocks that are listed offshore - dividends and capital gains will of course be tax-free and they can be bought through local brokerages. As long as you have a satisfactory non-resident tax situation, you can also buy onshore equities without risking capital gains tax, but you will find that dividends have sometimes been subject to withholding tax, which you may not be able to reclaim. This is an area in which the Internet has opened up new possibilities for investors, as online brokerages and some investment sites and exchanges allow you to manage your portfolio quickly and easily wherever you are in the world.

 

Others


The physical barriers to international investing of a few years ago simply do not exist for today's expatriate investors. Expatriate investment is therefore not limited to funds and equities, but can also include other types of onshore investment activity such as real estate, derivatives trading (futures and options), and their cousins spread-betting and contracts for differences. But it must be said that risk doesn't diminish with distance: arguably, if you are away from a particular market-place, with even the best on-line information sources you are somehow missing knowledge you might have had if you were present. These more exotic types of investment are not for the faint-hearted!

 

 

1.4 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. (Probably best not to go for the lump sum if you are likely to blow it all on fast cars and loose women - or men!) 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.

After a decade of low interest rates and unexciting equity markets, 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.

There is a review of the pensions regime in a number of the main 'high-tax' countries plus a comprehensive review of pensions investment possibilities in our Intelligence Report on International Pensions in the Lowtax Library. To see a description of this report, click here.







   

 

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