IHT may apply even if the member opts for death benefits to be paid at the scheme administrator or trustees’ discretion under the receiving scheme. Only if they survive for at least 2 years after the transfer will the usual treatment of discretionary death benefits apply. If the member does die within the 2-year period, not only will the transfer of value be liable for IHT, but the spouse’s exemption wouldn’t apply and so IHT could be payable even if the death benefits were paid to the spouse. This is because the death benefits are being paid from a trust rather than from the dead member’s estate to a spouse or civil partner.
However, there is a remedy available if the intended beneficiary is the member’s spouse or civil partner and the receiving scheme allows the option of death benefits being paid at the member’s direction.
If direction is chosen in the receiving scheme, on death within 2 years of the transfer, the transfer of value will potentially be liable for IHT, but the spouse’s exemption will apply if payment is made to a spouse or civil partner. If the member survives 2 years, they can consider changing from direction to discretion (where beneficiaries are chosen at the discretion of the scheme administrator). This will mean that normally no IHT will apply whoever the beneficiaries are.
The Staveley case clarified the circumstances in which IHT on transfer will apply.
IHT is likely to apply when the intention of the transfer is to confer a ‘gratuitous benefit’ to the beneficiaries. Translated from the legalese this means the member knew they were in ill-health and transferred in order to get better death benefits. That would include most transfers from defined benefit (DB) to defined contribution (DC) schemes and DC to DC transfers where the ceding scheme didn’t provide flexible benefits and the receiving scheme did.
However, where it’s a straightforward DC to DC transfer where the same range of death benefit options apply in both schemes and the beneficiaries aren’t changed in the receiving scheme, no IHT should apply even if the member knew they were in ill-health before the transfer.
Even if IHT does apply, this is based on the transfer of value not the transfer value. This might seem like semantics but it’s amazing the practical difference one word can make.
The transfer of value is the difference in the value of the death benefits in the previous scheme and the retirement benefits in the receiving scheme that’s used to calculate the IHT.
An example of the calculation can be found in our How inheritance tax might apply to a pension transfer article