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Tax on Pensions
Well, another summer has passed and contrary to my previous blog I have
decided not to become a communist, not that I think there was ever any
chance of it happening anyway. Being a financial adviser pretty much
excluded me from the start.
Anyway, as the hot days roll on here in Rome and the fresher ones will
start soon, I was thinking how I could get started on some more serious
topics of finances for residents in Italy. One thing I have come
up against this summer on a number of occasions has been the subject
of personal private pensions, and how they are treated for taxation,
so I thought it might be a good idea to explore the different types of
personal pensions which are in existence in the EU, which type Italy uses
and what we can learn to help us understand the taxation of such a
financial product in Italy.
EET, ETT, or
TTE?
This subject can get complex, but every so often it's
good to delve in and try to make some sense of it. The main
problem is that throughout the world, and even between European
states, different models of taxation are applied to the different models of
personal private pensions that exist. Italy has adopted one of these
models, which in itself is no problem, but when we, as
foreigners, move to Italy we may find that our existing private pension
plans don't fit into the same model as the Italian one. In most
cases our commercialista has the 'enviable' job of
choosing how to apply the Italian way to our scheme. It's a bit
like trying to fit a square peg into a round hole.
So what are the main models? As the title of this paragraph
alluded to, there are three main models used which go under the
monikers: EET, ETT and TTE.
What do these stand for?
The initials mean the following:
EET: Exempt, exempt, taxation. (The majority of EU member
states adopt this approach, including the UK)
ETT: Exempt, taxation, taxation. (Italy, Sweden and Denmark
adopt this model)
TEE: Taxation, taxation, exempt. (This used by Hungary
and Luxembourg)
**The US also falls in the EET system**
As you might have guessed, the 'exempt' and 'taxation' tags refer to
the point at which taxation is applied to the monies in your private
personal pension. So, the first tag refers to the point at which the
contribution is made into the pension fund (monthly or lump sum
payments are treated equally), the second tag refers to the money when it
is invested and accumulating within the pension (capital gains and
income generated from the invested funds) and the third is the point
at which one goes into retirement and starts to receive payments from it
(the actual pension payment). Clear as mud? Let's continue...
The EET model
The UK, US and many other EU member states apply the EET model
(exempt, exempt, taxation), and it is my favourite model! I think it is the
easiest to understand and the fairest model. I also expect that this
model may also be adopted (or phased in) by Italy as part of Mario Draghi's
big tax shake up, for which we are still waiting for details (end
October is the latest news).
Fundamentally, a model which allows someone to accumulate funds in a tax
efficient environment throughout their working life and then be taxed at
normal tax rates when they eventually come to take that money back, would
seem to be the easiest and fairest way to allow individuals to accumulate
as quickly and efficiently as possible. It also incentivises people to
want to make more contributions into these types of savings plans for their
future.
The ETT model
However, our beloved country of residence, Italy, adopts the ETT
(exempt, taxation, taxation) model. Interestingly, the other
two countries which adopt this model in Europe are Sweden and
Denmark. I don't think I need to point out the significant difference
between the social security systems of Denmark and Sweden versus Italy, but
it merely highlights the fact that Italy remains a higher taxing EU
state. That being said, I love Italy, as I know a lot of you do,
and it deserves much more than an critical look at its taxation
system. The fact that the fund is taxed in addition to the
pension payments on retirement means that their model doesn't
complement sufficiently the lower benefit payments on offer from the
state through the contributi scheme, previdenza
complementare' and is not a great attraction for savers for
retirement. However, you need not take my word for it. Between Italian
workers, private individuals and public scheme employees, only
25% contribute to a separate private pension scheme to top up their
existing benefits from the state. That figure is well below the EU
average!
That low number might be due to the fact that between the low tax benefit
(a maximum deduction against tax of only €5164.57 per annum), the rates of
tax applied to the fund itself (between 20% and 26% depending on which fund
you hold your private pension with), the restrictive ranges of investment
options and the higher charges, then it comes as no surprise that not
enough people are choosing to top up their pension with a private
arrangement, but are more likely to buy property or find other ways of
supplementing their retirement income, assuming they have surplus income
after the state has taken their contributi for the state
related pension.
There is, however, one advantage. The monies when received as an
income payment in retirement attract a tax rate of 15% and can fall to 9%
if you have contributed for 35 years to a previdenza
complementare. This additional benefit stills fails to be
attractive enough for people to save in this way for their future, probably
because the benefit is too far in the future for many people to even
consider when they have more pressing financial needs today, which
brings us back to the point that the incentive for people to save today
needs to correspond to a benefit received today i.e. a tax break on
contributions, or no tax on the invested fund.
So what does this mean for the taxation of your non-Italian
pension
As you might imagine it's not as simple as saying that a personal
pension that you own from one country will be considered the same, for tax
purposes, as an Italian private pension (previdenza complementare).
The complexity lies in the fact that because Italy cannot analyse
every different type of pension in the world, it is impossible for
them to legislate for each one as well. Therefore, we have to
use some logical thinking, but even that may be interpreted
differently by the tax authorities in Italy.
At this point you might want to take a moment's silence for your commercialista whose
job it is to make that interpretation and on whose shoulders, ultimately,
that decision lands. Although it is unfair to say that they don't have any
information to hand, because one client, whose commercialista was
clearly on the ball, alerted her to an 'Istanza di Interpello' dated
27th May 2020, (click HERE, basically
it is an opinion provided by the Agenzia delle Entrate on
a specific case presented by a specific individual). This interpello went
some way to explaining the thinking of the Agenzia behind
the taxation of pensions which fall into the EET model (exempt, exempt,
taxation). The 'opinion' was based on a UK pension.
Taxation on accumulation or not?
What it all seems to boil down to is how the pension is taxed
during the accumulation phase. Italy taxes the fund during this phase
but gives a preferential tax rate when the monies are drawdown. A
UK pension, for example, is not taxed during the accumulation phase,
but then drawdowns are taxed at regular income tax rates. So,
going back to the logical thinking approach, if someone moves to Italy with
a UK pension, it doesn't make sense that they would benefit from tax efficient
growth in the fund AND be provided with a preferential tax rate on
drawdown. That would constitute a double tax benefit, which I doubt
the tax authorities would approve of.
It doesn't matter what you or I think!
The interesting point here is that even with all this information
and supposition, the reality is that your commercialista can
still choose to apply any method of taxation that falls in any of the
different models because the legislation doesn't exist to do
otherwise. Therefore, the best you can do is to take a guess.
Attention, however, because the Interpello from 27th May
2020 gives a pretty good outline into the thinking of the Agenzia regarding
the EET model, in that when payments are taken they should be taxed at
income tax rates, not the 15% preferential tax rate. If you are
advised to, or you choose to apply the 15% preferential tax model, there is
always the chance that the Ageniza could come looking at some point in the
future. It's highly unlikely given the circumstances, (in my opinion), but
not beyond imagination.
Given the complexity around pensions it comes as no surprise that it is
often easier to bury one's head in the sand rather than checking exactly
what you have and how it should be declared. If you have any
doubts then you can always contact me for a free no-obligation analysis of
your situation. It is a part of the overall service package
that I provide to clients and others looking to regularise their
pensions arrangements in Italy. For clients, I also liaise with their commercialista
directly to clarify their current choices and determine if anything should
be done differently. Staying on the subject of pensions
For anyone who is intending on living away from the UK permanently,
we have over recent years been helping clients review existing UK
private pension arrangements to determine whether a QROPS transfer may be
appropriate. This is a type of overseas pension, which operates
like a UK private pension plan, is always domiciled in Europe for EU
resident individuals and is operated under an EU framework of compliance
and oversight.
Since the UK's exit from the EU we have been wondering whether the
UK would stop the possibility to move pension monies from the UK into
the EU to slow money flows out of the country, out of spite or any other
number of reasons relating to the future relationship with the EU.
To date this has not happened, but could be announced in any UK
budget. (the next budget has been announced for the 27th October 2021).
There are potential tax consequences of having a UK pension plan which is
now no longer 'harmonised' with EU legislation and there could be adverse
tax consequences in the future. In addition, moving pensions to
QROPS is considered removing a tie to the UK for anyone looking to
remove UK domicile for inheritance tax purposes. Therefore, if you
have a private personal pension arrangement that you are waiting to receive
benefits from and /or drawing down from, I can offer a free
analysis of the benefits of transferring it away from the UK.
Should you be interested in a no obligation pension review then you can
contact me on gareth.horsfall@spectrum-ifa.com or
call/message me on 3336492356.
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