Helping solicitors with inheritance tax and pensions

24 October 2018

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Clare Moffat looks at how you can help solicitors understand the implications of IHT on pensions and how this can affect their clients.

Do your solicitor connections understand the changes to death benefits and the implications they might have? It’s important solicitors aren’t straying into giving financial advice.

Why now more than ever?

Inheritance tax (IHT) statistics published on 27 July 2018 stated that “IHT receipts totalled £5.2bn in 2017/18; an increase of 8% (£388m) compared to 2016/17”.

More and more people are paying IHT so planning’s more important than ever. Estate planning solicitors know that pensions normally aren’t subject to IHT, but what about those circumstances where they are? This is where you can help them through the complexities of IHT and pensions.

When is IHT payable on pensions?

Pension freedoms have helped make pensions even more attractive, by allowing them to be cascaded through the generations. If the pension’s a discretionary defined contribution scheme then these aren’t normally subject to IHT. But when is it payable?

Contributions

Contributions aren’t usually lifetime transfers but they‘ll be subject to IHT if:

  • The member knows they‘re ill and in the last two years they’ve increased their contributions. For example from £100 a month to £1,000 a month. This would be a transfer of value as they’re knowingly trying to move IHT-able estate to an IHT-friendly environment.
  • The contributions are being made to someone else’s pension. IHT won’t apply if there’s a valid exemption, such as the annual exemption of £3,000 or the normal expenditure from income exemption.  Otherwise the contributions are potentially exempt and the normal seven year rule applies.

The estate is entitled to benefit or binding nomination

There are situations where there’s a contractual entitlement for the estate to benefit. Examples of this are: retirement annuity contracts which aren’t under trust and guarantee payments or arrears due from an annuity contract. In addition, if the member had the right to bind the scheme then the benefits are subject to IHT. Find out more about the difference between discretion and direction.

Transfers

Since pension freedoms, we’ve seen an increase in transfer values with many clients transferring their defined benefit (DB) schemes. Sometimes this can be as a result of ill-health. If a client has no dependants and stayed in the DB scheme then benefits would cease on their death. However, if they transfer to a discretionary defined contribution (DC) scheme, their beneficiaries can benefit.  

Any transfer or switch, if DB to DC or DC to DC, is a transfer of value. IHT may be payable if the transfer or switch happens within two years of death.  If the member knows they’re terminally ill and their life expectancy is less than two years then they aren’t going to live to see their retirement savings. Technically they could transfer to a scheme where death benefits are paid to the estate and IHT would be automatically due. The IHT payable is calculated by working out 40% of the loss to the estate. This is less than 40% of the transfer value, but it can still be a substantial amount. HMRC look at this on a case-by-case basis.   The situation in relation to DC to DC transfers is also complex. The publication of the Staveley case judgement on 16 October, which HMRC won at the Court of Appeal, may have an impact. Next month’s newsletter will have a discussion about the implications of this case.    

What can you do to help?

If a client visits their solicitor in ill-health and wants a will drafted, then this is the time for the solicitor to ask them about any changes they‘ve made to their pensions. The solicitor should find out:

  1. What type of scheme it is
  2. If they’ve made any changes in the last two years
  3. If they’ve made any contributions for others in the last seven years

Knowing the answers to these questions will help when winding up the estate and calculating the IHT payable. It’s important that you can help your solicitor connections to be armed with as much information as possible to help prepare the client and their beneficiaries.

About the author

Clare Moffat

Head of Business Development, Royal London

Clare qualified as a lawyer and Notary Public in September 2002 and is a member of the Law Society of Scotland. Post qualification Clare spent 5 years at Aegon Scottish Equitable in the legal department before moving to Pinsent Masons LLP in November 2007. While at Pinsent Masons, Clare acted for many different pension providers before moving to Prudential for over 6 years and ended up leading the pensions side of the external facing technical team which involved presenting, writing articles for the press and developing adviser facing content. Clare joined Royal London in April 2018 to head up the external facing team of pension and protection experts.

Last updated: 25 Oct 2018

This website is intended for financial advisers only and shouldn't be relied upon by any other person. If you are not an adviser please visit royallondon.com.

The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.