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Danby Bloch: A warning on IHT and pensions

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The tax position of pension scheme death benefits now looks very attractive and advisers are understandably getting more excited about the planning possibilities. There is much talk of an estate planning revolution, with wealth cascading down the generations. However, a fully paid-up member of the awkward squad might ask: how confident are we this benign situation is really going to last?

The fact is some people in this country are just not that enthusiastic about wealth cascading down the generations in this way. So it might not last. New style pension and inheritance tax planning over the long term looks like a great opportunity but let us not forget all the other estate planning weapons in our rush to embrace this shiny new one.

First let’s remind ourselves of the new rules. The tax position on the fund paid from a defined contribution pension after death depends on when they die. Basically:

  • If the person’s death occurs before age 75 the fund is free of tax, regardless of whether the individual had started to draw their pension or not.
  • But if the person dies at the age of 75 or later the nominated beneficiary will be able to access the pension funds flexibly, at any age, and pay tax at their income tax rate.

As things stand, this can go on generation after generation. There is no IHT and the recipient only pays income tax when drawing income from these otherwise pretty much tax-free funds. It looks brilliant for anyone who has built up a fair sized fund and is something of a disincentive to spending it.

But what would happen if the Government changed the rules? It could happen any time. The kind of estate planning envisaged is only crystallised when someone dies. So it might well need several decades of legislative stability. Adverse changes to the rules could hardly be described as retroactive or retrospective, although in some sense it would be both these. It would be like increasing the rate of capital gains tax or stamp duty land tax in the way it would apply to existing assets investors hold. Or even mansion tax. So it is certainly not inconceivable.

What are the forces that might push a Government towards tightening up or reversing the new pension rules? One question almost any politician might ask is whether setting up this kind of

IHT-free fund is a good use of tax relief on the initial pension contributions.
Another driver is the need to cut the Government’s deficit. Of course, Labour is keener on increasing tax than the Tories and the impact on the exchequer would be minor and long term.

Arguably, however, it might be a signal that “we are all in it together”.

Whether one likes them or not, there have been quite a few growing pressures towards more egalitarianism. There is also a powerful wish of many politicians to stop growing inequality of wealth – traditionally the role of estate taxes. The fight against inequality is currently a powerful movement and has been taken up by politicians on all sides. So far all the impact of this approach has been evident in the popularity of the mansion tax, anti-non-dom tax proposals and the crusade against tax avoidance.

It is true IHT is a surprisingly unpopular tax with over 50 per cent thinking it unfair. But as only about 3 per cent of estates pay the tax, one might conclude a lot of people have not yet joined the dots. They could change their minds in time.

So returning to a relatively penal tax on pension death benefits is a perfectly feasible outcome – however unwelcome advisers and their clients would find such an eventuality.
How should this affect advice to clients?

The first suggestion is not to put all your estate planning eggs into the pension planning basket. It makes sense to use this strategy while it is available. But advisers should not ignore all the other estate planning weapons in their armoury: will planning, gift and loan trusts, discounted gift trusts and so on. At least these plans crystallise the gift at a time when the law is more or less known and understood, rather than waiting for some moment in the future when everything could have changed.

Also it is essential to warn clients tax law can and often does change and make sure they understand this.

But one of the simplest and most effective types of IHT planning is the purchase of investments that qualify for business property relief. It is relatively simple, takes just two years for clients to qualify for it and allows the investor control and access to the assets while they are still alive. Death wipes out CGT and transfers the asset free of IHT.

BPR investment makes lots of sense but of course the law could change at some point in the future for these assets as well, although the changes are probably lower. So much the same sorts of points apply, although the risks should be less because the timescale for planning with these assets is usually a lot shorter.

Danby Bloch is chairman of Helm Godfrey

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. What a poor article. Of course things can change.

  2. Sascha Klauß 12th May 2015 at 5:01 pm

    “It is true IHT is a surprisingly unpopular tax with over 50 per cent thinking it unfair. But as only about 3 per cent of estates pay the tax, one might conclude a lot of people have not yet joined the dots.”

    Pernicious way of thinking. I propose having everyone with a surname beginning with A lined up against a wall and shot, then confiscating all their assets and distributing them to the rest of the population as a tax-free cheque. Bizarrely, I find that 99.99% think this is unfair even though only 5% of them will be lined up against a wall and shot. Clearly a lot of them haven’t joined the dots.

    If a law is unfair then it is unfair, whether it affects you or not. I could go even further into Godwin territory by pointing out that most people think that anti-homosexuality laws are unfair, even though only around 5% of the population is gay (using the narrow definition).

    Having picked that particular nit, I should say that I agree with the main points of the article. But in the end we can only advise on the laws as they are.

  3. William Burrows 12th May 2015 at 5:48 pm

    Don’t be fooled by the simple way Danby explains this -in order to things simply you really need to know your stuff.

    Take this line – The first suggestion is not to put all your estate planning eggs into the pension planning basket

    This is simple but very good advice and is totally in line with the trend to arrange more than one retirement income solution

  4. John Blackmore 12th May 2015 at 6:47 pm

    Can’t see why a pension fund should be IHT free after NRD and yet an ISA fund would suffer IHT. would be quite happy for ISA to be treated in the same way as pension – either making ISA funds free or charging IHT on pension.

  5. David Stoddart 13th May 2015 at 6:43 am

    Do you not think the govt thought about this when they brought the new rules in. Chances of someone dying pre 75 = slim. Chances of someone dying post 75 = high. Therefore is there income tax payable by the receiptant? Chances yes unless they can withdraw it within the personal allowance. Why have the govt allowed full access for retirees? It is alleged that people will ignore advice and take large chunks of their pensions and pay income tax. Are beneficiaries of pension pots going to want to take the money and spend it and at the same time create an income tax charge? Possibly. So what I am trying to say is that I think the govt have thought this through and the tax take might be the same or very similar with the new rules. Obviously we as planners would look to mitigate where we can and plan but not everyone takes advice unfortunately for them.

  6. Trevor Goodbun 13th May 2015 at 8:30 am

    In 2006 the new rules on pensions were introduced as pension simplification. If my memory serves me correctly part of that revision was the introduction of ASPs which in some circumstances could be used as a highly effective means of estate planning. I seem to recall that lasted about a year before that particular loophole was shut. The revisions in 2006 followed many years of consultation and research. What chance do we really think that populist reforms rushed through in the run up to an election will stand the test of time?

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