There is little doubt recent legislative changes have laid a couple of golden eggs from money purchase pensions. First, the ability to access funds in retirement with almost unfettered flexibility. Secondly, upon which I shall concentrate, greater flexibility for death benefits coupled with removal of some draconian tax charges.
Hitherto, only dependents (in essence, surviving spouse, children under 23 or others financially dependent on the member) could “inherit” a pension with all other payments having to be by way of lump sum. Now pretty much anyone can “inherit” the member’s fund as a drawdown pension, annuity or lump sum. Furthermore, an inherited drawdown pension can be passed on again on the inheritor’s death.
Whereas under the previous regime an immediate 55 per cent death tax charge applied to any crystallised funds and all funds from age 75, the tax reins have been similarly loosened. Now, where death occurs before age 75, all death benefits, in whatever form, will be tax free. For deaths from age 75, there is tax but, as opposed to an immediate 55 per cent charge, it will apply only when the beneficiary receives the money either in lump sum or pension form. In most cases the tax bill will be much less than previously.
These are big changes and will alter thinking in terms of the interaction of money purchase pensions in overall succession and estate planning. However, it is here (remembering Aesop’s fable) we must not kill the pension goose with overzealous action motivated by wanting just a bit too much. Using a pension for the sole intention of inheritance tax planning is potentially dangerous ground.
It is true that provided pension death benefits are paid at the discretion of the scheme, such amounts do not generally form part of the deceased’s estate, meaning funds can effectively pass to the next beneficiary free of IHT. However, there is no out-and-out exemption as such from IHT for individual pensions but more an application of general IHT principles coupled with the odd legal provision.
At the heart of IHT is the concept of a gratuitous disposition (and that means pretty much any disposal or transfer that is not an arm’s length sale) whereby the value of my estate is reduced. That is a transfer of value and with it flows IHT consequences. For the most part, it cannot be argued my pension contributions are dispositions from my estate because they are made to save for my retirement. If you like, any IHT advantage derives not because I am planning for my death but exactly the reverse – I am planning for my retirement, which, as an aside and because of, I get a particular IHT treatment.
Pensions are about saving for one’s own retirement and beware if that is not the intention. If it can be shown the intention was never to save for retirement but rather to convey monies from the estate through pension death benefits, then based on previous form, we might well expect HMRC to take issue.
Previously, omitting to take one’s pension (in effect, thereby enhancing death benefits) was considered a disposition for IHT. That has now been changed by legislation but that goes no further than to say omitting to take a pension is no longer a disposition. It has not changed the fundamental principle that if pension contributions or transfers are being made with the primary intention to gain IHT advantage it is open to challenge.
A glance at HMRCs’ IHT manual will show you the legal analysis can be complex, the basis of challenge uncertain and even somewhat fanciful, particularly around “ordinary” pension transfers close to death. On death, form IHT409 will be completed, which provides relevant pension facts for HMRC to investigate if necessary.
With vast changes to pension death benefits it would probably be helpful to see updated IHT guidance. The Government acted quickly to negate the omission issue so it would also be no bad thing to understand central thinking on IHT and pensions. Absent that, we are where we are. This means if there is clearly an intention to reap IHT advantage with no intention to save for retirement it is potentially dodgy ground. This is not to say the succession planning possibilities associated with pensions should not be properly enjoyed; simply that, for the time being at least, do not try to squeeze a golden IHT egg in haste to repent at leisure over the dead goose.
Paul Kennedy is head of tax and trust planning at Fidelity FundsNetwork