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Experts warn of death tax hit after two-year deadline

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People inheriting pension savings must decide what to do with funds within two years of the member’s death or risk being hit with unnecessary tax charges, experts warn.

The coalition Government abolished the death benefit tax on pensions in drawdown or value protected annuities if the member dies before the age of 75.

However, this only applies if the beneficiary either moves into flexi-access drawdown or takes a lump sum within two years. If they do not, the assets will be treated as if the member died after 75 and taxed at the beneficiary’s marginal rate, or 45 per cent if taken as a lump sum.

Talbot and Muir head of technical support Claire Trott says moving funds into flexi-access drawdown “can be a real benefit for those with illiquid assets such as a commercial property”.

She says: “There have been cases where the beneficiary would like to take the lump sum but isn’t able to realise the asset within two years. It is then possible to designate into flexi-access drawdown before the two years are up and then when the asset is sold the fund can then be paid out as a single income payment free of income tax.”

AJ Bell head of platform technical Mike Morrison adds  while recent reforms have increased the appeal of pensions as a way of passing down wealth, advisers need to be wary of exceptions.

These include a possible HMRC tax charge if a member contributed to or transferred their pension for the purpose of passing on assets, rather than providing a retirement income.

For instance, the tax office’s “two-year rule” could mean beneficiaries are hit with an IHT charge if a member known to be in ill health dies within two years of making a transfer.

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. “could mean beneficiaries are hit with an IHT charge if a member known to be in ill health dies within two years of making a transfer.” Every I see this trotted out by the techie’s for punters to worry about (usually to do with the stupid potential for tax on discretionary trusts of life and terminal illness policies), I wonder if it actually gets picked up in reality. Anyone seen such a case??

    • Unfortunately I know of such an instance. Client transferred her DB scheme in order to obtain access funds and flexibility over how and when to draw income. Then diagnosed with terminal illness a few months later and died shortly after. Despite evidence proving that client did not know of illness HMRC applied the two year rule. IHT payable as a result.

    • Providers are required to report to HMRC on an IHT409 form all deaths occurring within 2 years of transferring. At a Standard Life seminar yesterday, they mentioned that HMRC chased an estate for tax after a death claim, for a pension fund worth £72,000 which was within that 2 year period.

  2. I was reviewing the IHT forms the other day for a client query and it does actually ask about transfers of pensions in the last 2 years, but not about health. I think it is something that we have to be mindful of as there isn’t sufficient case law or detail to know if this is something they are actively seeking to enforce.

  3. Charles Seymour-Cole 29th May 2015 at 10:13 am

    I am in this position with a client at the moment. He transferred his DB scheme to a PP knowing he was in Ill health and unlikely to survive the two years. This was before Osborne made the pension changes to bribe the electorate. His thinking being that his Wife would get a larger pension from the PP on his death than from the DB scheme, even if the Revenue take the 40%. He has now died (over Easter actually) approx. 1 year after the transfer at the age of 64. Expression of wish says 100% to his spouse. We are now waiting to see if the revenue come knocking. But even if they do she will still get a larger pension than the DB scheme death benefit offered and now of course it will be a tax free income.

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