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Pensioner Cell Block H?

British justice is founded on the principle that we are innocent until proven guilty. A similar principle guides the application of inheritance tax law to pensions.

It says pensions are free from IHT unless you deliberately use your pension to avoid paying tax. HM Revenue & Customs now wants to abolish this principle and replace it with the exact opposite.

HMRC’s discussion paper on IHT and pensions, published in July, is reaching much further than the pension industry had expected. It suggests that once people reach retirement age, their pension fund – whether vested or not – is subject to IHT. The only way to avoid a tax charge is for the deceased’s personal representatives to prove to HMRC that the deceased’s actions in life, relating to their pension, were not intended to reduce the amount of IHT payable after their death.

In simple terms, this means that everyone approaching or in retirement needs to document every decision taken regarding his or her pension. This is the only way that personal representatives will be able to prove that decisions were taken with- out tax avoidance in mind.

This is bureaucracy gone wild. If the Government’s Better Regulation Task Force – whose aim is to reduce the administrative burden on business, government and population caused by regulation – were aware of HMRC’s plans, it would be enough to make them flip their collective lid.

HMRC also wants you to reconsider what you do with your pension fund if your state of health changes. For example, if you are diagnosed with an illness which means that you might not live to age 75, HMRC expects you to convert any unvested fund into an annuity. This rule will kill off phased vesting at a stroke and flies in the face of the Department for Work and Pension’s intention to soften the cliff edge between work and retirement.

The paper says the only way to avoid IHT is to turn your whole pension fund into an annuity as soon as you possibly can. Even then, there is a catch. If you choose the new option of value protection or a 10-year guarantee, there is a presumption that you have done so deliberately to diminish your estate.

Perhaps the most objectionable implication in the paper is that, even where a spouse or financial dependant inherits the deceased’s pension fund, IHT could still be payable. Inheriting your husband’s, father’s or mother’s pension fund might be exempt by virtue of spouse and dependant exemptions contained in the Inheritance Tax Act 1984 (sections 18 and 11) but this is far from clear.

The reason that HMRC gives for this fundamental shift in thinking is the availabilty of alternatively secured pensions from age 75. Most would agree that there are ways to use ASPs to avoid IHT but how many people are likely to buy an ASP with estate planning in mind? One per cent? Two per cent? In truth, the vast majority are likely to have turned their pension fund into a guaranteed annuity long before they reach the ripe old age of 75. Which is why this change of policy looks like a very big sledgehammer to crack a very small nut.

HMRC needs to have a radical rethink of its plans. Attempting to govern the tax treatment of pension options such as ASPs and phased vesting with 20- year-old IHT law will not work. We need a modern approach to deal with modern pension choices. In the meantime, the current light-touch treatment will suffice.

Within five years, the chance that hordes of people will die while drawing money from their ASPs with estate planning on their mind is remote. That gives HMRC plenty of time to come up with a more permanent solution. And hopefully one not founded on the presumption of guilt.

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