Landmark court case sees pensions transferred in serious ill health liable to significant tax charge
There have been some very interesting developments lately with regards to pension transfers in serious ill health – in particular around inheritance tax. In a landmark ruling, the Court of Appeal has found in favour of HM Revenue & Customs in a case commonly known as the Staveley case.
As a result, anyone who makes a pension transfer in ill health could be subject to an IHT bill.
The case in question concerned the estate of a woman who transferred her Section 32 contract to a personal pension to avoid her former husband benefiting from it. The transfer took place just weeks before the woman, Mrs Staveley, passed away in 2006 after developing cancer two years earlier.
Her personal pension passed to her sons and HMRC claimed IHT on the basis there had been:
A transfer of value which reduced her taxable estate at the time of transfer;
An omission to exercise a right with the intention of deliberately increasing the estate of another, which led to a lifetime transfer of value immediately before death. This is on the basis Staveley could have taken retirement benefits but chose not to.
The sons challenged the decision, bringing the case to the First Tier Tribunal, which found in their favour and which was backed by an Upper Tier Tribunal, before HMRC took it to the Court of Appeal.
At this point, it should be noted the original transfer this case relates to took place in December 2006, just after the introduction of pension simplification.
This has a bearing on the case and how it would be viewed now because a few things have changed.
The omission to exercise a right rule is no longer relevant. This was where IHT could be payable if benefits were available but were not accessed. This changed in the Finance Act 2011. In addition, pre-A day death benefits in occupational pension schemes, including Section 32 plans, were limited to Inland Revenue maximum benefits and any excess could be refunded to the sponsoring employer.
Death benefits are no longer limited like this, so it is not likely to be a driver for transfer in the same way as in the Staveley case.
Need to know
That said, it is vital advisers are aware of the IHT issues when it comes to pension transfers.
The main one is that, during the transfer, the right to decide who receives the death benefits comes back to the estate and is then taken back out of the estate once the benefits are at the discretion of the receiving scheme administrator.
If the member is in good health, the death benefits have little or no value, so nothing is deemed to have been given away. However, if the member is in serious ill health, the death benefits have a value to the estate and a transfer of value for IHT purposes can occur. If the member does not survive the transfer for two years, it must be declared on the IHT 409 form and HMRC will decide if IHT is payable.
Previously, it had been thought that, if a Section 10 exemption could be proved, it would not be subject to IHT. Section 10 of the IHT Act 1984 refers to the “intention to confer a gratuitous benefit” or, more importantly, the lack of intention.
The Court of Appeal overturned the other tribunals’ findings that there was no intention, even though it was clear Staveley’s intention was to prevent her ex-husband from benefiting from her pension on her death. There are other factors to bear in mind too. In calculating the transfer of value, the deceased member’s pension rights before the transfer need to be considered.
For people who transfer at age 55 or over into a flexible pension plan, the value of these rights can be significant and could considerably reduce the transfer of value.
Indeed, for people who had a (provable) expectation of life of more than three years, the next transfer of value could be significantly reduced because of actuarial calculations.
In many cases, advisers who have considered the issue of the two-year rule in relation to transfers assume there is only a problem if the transfer changes the resultant beneficiaries or the type of death benefit.
This is not the case. All pension transfers or switches have the same issues when it comes to IHT. The point at which the fund transfers, irrespective of the type of scheme, is when the death benefits are deemed to return to the estate. So if they have a value because of serious ill health, an IHT charge could occur.
As noted, there are many factors to consider when establishing how much the transfer of value really is and, in many cases, it may be negligible. That said, this issue cannot be ignored in cases where the client is in serious ill health.
Claire Trott is head of pensions strategy at Technical Connection