A recent case has highlighted a controversial approach HM Revenue & Customs applies that can subject a member of a registered pension scheme to unexpected inheritance tax charges following a transfer.
The situation can arise if the member transfers their benefits when they know their life expectancy is impaired and they die within the following two years (or later in certain circumstances).
One of the major problems is it is unclear how HMRC values the taxable sum, as there is very limited guidance in the public domain.
Hearing HMRC’s message
The case involved a woman called Mrs Staveley, who, following a hostile divorce, transferred pension benefits into a personal pension scheme when she was terminally ill in November 2006.
Originally, she had been advised the potential death benefit within HMRC’s allowable limit would have been paid into her estate, thereby making it potentially subject to IHT. Any excess would have been returned to the original sponsoring employer, which was controlled by her ex-husband.
By contrast, the potential death benefit from the personal pension was the full fund value, distributed at the discretion of the scheme administrator, and Mrs Staveley completed an expression of wish form to tell the scheme administrator she would like any death benefit to be distributed to her two sons in equal shares.
In December 2006, Mrs Staveley died without crystallising her personal pension benefits. As she knew she was terminally ill when she made the transfer, HMRC treated it as a “chargeable lifetime transfer” followed by an “omission to act” (by not drawing any personal pension benefits), arguing the two actions were associated and deliberately designed to reduce the value of her estate for IHT purposes. Consequently, they applied an IHT charge.
Mrs Staveley’s legal personal representatives and two sons challenged HMRC. Following a previous first-tier tribunal decision, the Upper Tribunal of the Tax and Chancery Chamber rejected HMRC’s arguments in January.
The court decided any IHT advantage gained from her transfer and not taking any benefits was not intended to confer gratuitous benefit, as the main reason was to prevent any excess element from being returned to her ex-husband’s sponsoring employer.
Following this judgement, some commentators have argued HMRC will have to change its interpretation of the relevant parts of the Inheritance Tax Act 1984. However, the individual circumstances of this case – where Mrs Staveley was heavily motivated to prevent any money from her pension falling under the control of her ex-husband – do not automatically set a precedent for any future pension transfer case.
While HMRC’s approach could change in the future, advisers in the meantime need to explain to their clients when making a pension transfer could lead to an IHT charge. Consequently, for any client who knows their life expectancy is impaired, advisers should continue to undertake a full appraisal of their situation. A good practice is to assume the worst case scenario, that is, that the full transfer value is taxable.
All that said, even with the possibility of IHT, a transfer may still be beneficial, for example, if there was no (or a very limited) death benefit payable from the member’s scheme and a much higher one (even after taking account of any IHT charge) payable from the receiving scheme.
Jon Greer is pensions technical expert at Old Mutual Wealth