This may seem a peculiar title for an article but tax systems the world over can be peculiar, and Spain is no exception. In this article we review the types of foreign ‘retirement pension’ and explain how they are taxed in Spain.
How can this be so significant? Because in some cases pensions paid from other countries can be either:
- Completely exempt from tax in Spain
- Partially exempt from tax in Spain
- Subject to the lower tax rates than usually applies
- Be treated as investments with the cost of contributions deductible from income received.
Let’s first remember that being a Spanish resident means that you are subject to Spanish income tax on all your worldwide income.
Let’s now look at the typical kinds of income many of us would consider to be included in the term ‘pension’.
State paid pension
No surprises here. A pension paid by the social security system of any country is exactly what it says on the label. State pensions from any country are treated as earned income by the Spanish system.
The good news is that because pensions are treated as earned income, in addition to personal (5.550€) and age allowances (65+ 1.150€, 75+ 1.400€), an extra 2.000€ general deduction plus a further low income deduction of up to 5.565€ are available.
This means that a person over 75 years old pays no income tax on pension income below 14.000€.
Pension paid by a former foreign employer
Such income is treated as normal earned income by Spain, just like State paid pensions.
Pension paid by a foreign Government employer
In the case that a double tax treaty exists between Spain and the other country, pensions paid by former State employees are exempt from income tax in Spain. Most countries have a double tax treaty with Spain, including of course the UK. Brexit has not changed this.
This exemption applies to retired Government employed nurses, teachers, police, army personnel, civil servants and local authority employees of all types and even, sometimes, retirees of nationalised industries. In some cases, the tax authority of a country will publish a closed list of pensions that are considered as ‘Government’ pensions and this is very helpful to avoid arguments with the Spanish tax office.
The way the exemption works depends on the precise text of the tax treaty but, usually, the pension is not taxable but does use up Spanish personal allowances and lower tax rates. This can cause other income to be taxed at higher rates.
The country that is paying the pension has the right to charge income tax but usually allows the deduction of personal allowances.
Finally, there has been much confusion as to how United Nations pensions should be taxed in Spain and here again the subject is complicated and each situation needs to be reviewed to obtain the correct answers. Part of the confusion originates from guidance provided by the Spanish tax office which is not always been correct.
Foreign retirement savings / private pension schemes
This is where the most surprising differences exist. Foreign private pension schemes are not treated as pensions by the Spanish tax system and instead are subject to income tax like a savings or investment schemes, much like Spanish “Planes de Jubilación” that can be obtained from any Spanish high street bank.
Note that Spain also has ‘Planes de Pensión’ which are specially regulated private pension schemes, quite different to “Planes de Jubilación”.
These foreign retirement savings schemes often have exotic names like SIPPs, QROPs, TFSA, QNUPS, RRSP, 401k, Roth IRAs, ISAs, etc. They exist because many countries want to encourage saving whether for retirement or earlier age and offer favourable tax treatment, whether in terms of tax deductions for contributions made to a scheme, tax free growth of investments, or both.
Spanish tax treatment of these foreign schemes varies signficantly according to:
- Whether the funds are:sequestered and unavailable to the individual until retirement age.
- Whether managed by a financial institution or simply held in a designated brokerage account.
- How income may be drawn from the scheme having attained a preset retirement age.
Lump sum draw downs/withdrawals
One of the most important differences in tax treatment is where a jurisdiction allows a tax free lump sum withdrawal from a pension scheme, as exists in the UK tax system. This tax exemption does not work in Spain.
If the scheme is not a retirement savings scheme, i.e. is treated as a pension by the Spanish system, then drawing the tax free lump some should be done before becoming tax resident in Spain.
If the scheme is not defined as a pension scheme by Spain then the same applies but the problem is much less because retirement savings schemes enjoy a much better tax treatment in Spain.
For a retirement savings scheme, to work out how much taxable income applies to a withdrawal, you need to calculate the difference between the amount originally invested in the scheme and compare this with the amount withdrawn and the value of the scheme at the time of the withdrawal, all amounts being calculated in historic Euros. This is often a very complex calculation. The difference is regarded as a capital gain and tax is payable in Spain at between 19% and 26%.
The tax rates and bands are:
- 19% 0€ – 6.000€
- 21% 6.000€ – 50.000€
- 23% 50.000€ – 200.000€
- 26% over 200.000€
This treatment also applies where funds have been transferred into a Spanish compliant investment bond, often recommended when a person moves to Spain. These compliant bonds greatly simplify administration because the insurance company calculates what tax has to be paid and deducts this at source, providing the bondholder with details of what to declare in the annual income tax return.
In the case that part or all of the capital saved in the retirement scheme has been converted into an annuity then the Spanish system makes it simple to calculate the amount of taxable income.
In the case of a lifetime annuity this is set according to the age of the person at the time the annuity was contracted. As an example, an annuity contracted when a person is 65 is treated as 24% taxable income, the rest being treated as tax free capital return. The 24% taxable income is subject to income tax rates of 19%-26%.
In the case of a fixed term or temporary annuity, it is the contracted number of years that determines how much taxable income applies. As an example, an annuity that pays out for a fixed period of 5 years is treated as 12% taxable income.
For those with substantial pension pots trying to establish whether the assets of a retirement scheme is subject to wealth tax can be a particular problem. As a general rule, always dangerous in these matters, if the retirement scheme funds are ‘locked up’ and cannot be accessed until attaining a particular age or physical condition, then the funds should be wealth tax exempt.
However, as indicated, each foreign arrangement should be examined by a tax specialist to confirm the correct tax treatment.
In summary, the treatment of pensions in the Spanish tax system is not as straightforward as it might seem, which causes many to file their income tax declarations incorrectly and pay too much tax.
Unfortunately, the complications of the many types of foreign Government pensions, company pensions and private pensions/retirement schemes are not understood by persons who complete tax returns in Spain for clients. This should not really be very surprising as almost no relevant technical information appears in Spanish tax regulation guides.
It is also common for tax officers not to appreciate the significant differences in the schemes and sometimes taxpayers seek their guidance and get the wrong answers. Additionally, we have seen many instances where tax inspectors also make mistakes and over assess tax.
Unfortunately, there is no alternative, if you have these types of ‘pensions’, you need to make sure that your income tax declaration correctly declares such income.