Listen to our podcast with Clare Moffat and Fiona Hanrahan from our Intermediary Development and Technical team as they discuss the planning opportunities relating to IHT and pension death benefits.
Clare and Fiona cover some keys facts around IHT planning, including when IHT applies to pensions, the impact of the Staveley case and how HMRC knows when IHT applies to pensions.
Q: Pensions are always talked about as good for IHT planning – is that right?
Yes – in most cases pensions are not normally subject to IHT. Since the change in the omission to act rules this makes them a very attractive wrapper and assets subject to IHT should always be used first.
Q: But what about the cases where IHT does apply?
Contributions for you are not normally subject to IHT but will be subject to IHT if in the last two years the member has known they are ill and substantially increased their contributions. For example from £100 pm to £1000. This would be a transfer of value. Contributions for others will be subject to IHT unless there is a valid exemption such as the annual exemption of £3,000 or the normal expenditure from income exemption and that is a really important exemption which can be used by many people.
An estate might be entitled to the death benefits contractually and an example of that is when it has been set up under direction and that is something that we will look at in another session.
The main example we hear a lot about though is when someone transfers from a DB or occupational DC scheme to a fully flexible discretionary DC scheme and they are in terminal ill health and die within 2 years. Normally when you transfer you expect to live to see the retirement benefits but that won’t be the case if there is terminal illness. This will be a transfer of value and clients and their beneficiaries should be prepared to pay IHT. But in many of these cases the transfer is happening because if the member died in the DB scheme there would be no death benefits. 60% of something will still be better than nothing! But actually the IHT will never work out as much as 40% of the TV and we have more detail on a case study in technical central.
Q: There has been a lot in the news over the past few years about this and also a case called Staveley. It has changed the law hasn’t it?
No! The Staveley case was based on some very specific facts. One of these – in relation to omission to act – is totally irrelevant as the law changed on this in 2011. Point 2 - it was accepted by both sides that there was a transfer of value but the other point was in relation to when Mrs Staveley transferred her death benefit in ill health did she intend to confer a “gratuitous benefit” on her children. The Supreme Court found that she didn’t – which then meant it wasn’t subject to IHT in relation to that aspect. But this does not mean the same would apply to most clients. Mrs Staveley’s main intention was to deprive her ex-husband of the death benefits. Due to the type of scheme that it was, he would have received the death benefits and she did not want that to happen. So that isn’t a normal situation. In most transfers in terminal ill health the reason for the transfers is to ensure that someone does benefit when they might not have done before.
Q: So did Staveley have an impact?
Yes. The Supreme Court, by rejecting HMRC’s appeal on this point, shows that if a terminally ill client switches between two fully flexible discretionary DC schemes for commercial reasons with no change in beneficiaries, then section 10 would apply. The transaction is not intended to give gratuitous benefit.
Dealing with clients in terminal ill health is difficult. These clients often want to make things easier on their death for loved ones and that can often mean consolidating pensions or generally making sure that their affairs are in order. This judgement means an administrative process won’t cause more heartache in terms of IHT.
Q: How does HMRC know if IHT should be paid?
On death the PRs have to fill in the IHT400 and if any changes have happened to pensions within the last 2 years then the IHT409 form also needs filled in. 2 years is the rule which HMRC use in relation to pensions but there is nothing in legislation about this – it’s just practice. If something has happened in the last 2 years then HMRC will ask for more information. If a transfer happened and then someone was killed unexpectedly in an accident that would not be subject to IHT as it is all about whether that person expected to see their retirement benefits. In that example they would be fully expecting to live to see their retirement. But if HMRC discover that someone took action in relation to their pension and they knew they were going to die – there will be more investigations. If IHT is due then the pension becomes part of the estate.