Pension savers in ill-health are at a greater risk of being hit with a 40 per cent inheritance tax bill after a Court of Appeal ruling in favour of HM Revenue & Customs, experts have argued.
Currently anyone who is in ill-health, transfers their pension and then subsequently dies within two years could see their remaining defined contribution pot hit with an IHT charge.
Almost all transfers are granted an exemption from this charge as long as the transfer was not meant to confer a ‘gratuitous benefit’ on the member. These rules are set out in the 1984 Inheritance Tax Act.
The extent to which transferring members can escape IHT has been challenged by HMRC in a case involving one client, Mrs Staveley.
HMRC argued Mrs Staveley’s decision to transfer her pension and bequeath the money to her children – rather than leave it in the existing scheme and allow her ex-husband to benefit – conferred a gratuitous benefit on them.
The First Tier Tribunal found against HMRC and, crucially, noted “if [HMRC] was right, a transfer from one [personal pension plan] to another [personal pension plan] for commercial reasons (perhaps to get a better rate of return), without any change in beneficiaries, would be caught. We do not think that this was intended by parliament.”
The Upper Tier Tribunal subsequently backed this ruling following an appeal from HMRC – a decision it again appealed.
In a decision made in June this year but only now made public, the Court of Appeal finally found in favour of HMRC.
AJ Bell senior analyst Tom Selby says: “This ruling at best causes major confusion for pension savers in ill-health and at worst risks landing their beneficiaries with a shock 40 per cent tax bill on the money left behind by a loved one.
“It is frankly bizarre that someone who transfers from one DC plan to another now risks being hit with a 40 per cent IHT bill – even if the transfer doesn’t materially change the money that will be passed on if they die within two years.
“This is already something defined benefit members in ill-health can fall foul of, although whether or not this is the case depends on the interpretation of their intentions at the time.”
In January Chancellor Philip Hammond asked the Office of Tax Simplification to review the inheritance tax regime.
The OTS has split its review into two parts, administrative and technical, with its administrative findings to be published around the same time as the Budget on 29 October.
Selby adds: “What we are left with is a complex, nonsensical web of rules which risk layering on extra worry for beneficiaries at a time where they are likely to be suffering from serious emotional distress.
“Instead of allowing court rulings to determine whether IHT is due on retirement funds left behind, the government could radically simplify the system by exempting pensions from IHT altogether.”