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Segments squeezed dry

Anumber of providers have launched segmented section 32 contracts. Under the post-A-Day rules, each segment becomes a separate pension scheme.

This is beneficial for those with tax-free cash above 25 per cent of the fund, as it allows them to take a proportion of the total tax-free cash from each scheme. This gets round the post-A-Day rule applying to single-segment schemes, such as executive pensions, that requires the member to take their tax-free cash all at once where it exceeds 25 per cent of the fund.

The benefit of not taking all the tax-free cash up front is that, on death before age 75, the unvested s32 segments are not subject to the 35 per cent tax charge which applies to drawdown funds passed to the member’s estate on death before age 75.

However, the discussion paper on inheritance tax and pension simplification issued by HM Revenue & Customs in July suggests that unvested s32 segments are now likely to be subject to IHT on death before age 75.

Paragraph 26 of the document states: “A possible scenario could be where a member initially defers taking their pension when in good health but subsequently comes to believe that their life expectancy may be significantly curtailed. The charge under s3(3) arises, in principle, at the latest time at which the member could have exercised their right (for example, to annuitise). So a member who initially decides to defer taking a pension in order to maximise their future income may nevertheless be chargeable under s3(3) if they do not review that decision in the light of changing information about their health.”

What this paragraph is saying is that if the member fails to vest all the remaining segments as soon as they are aware of a change in their state of health, then the unvested s32 segments are likely to be subject to IHT.

Therefore, only those who die unexpectedly are likely to avoid an IHT charge on unvested s32 segments, since those who die otherwise are likely to be aware of their deteriorating state of health, even if that awareness arises only a few days before their death.

The most common causes of death between ages 55 and 75 (source: deaths in England and Wales, Office for National Statistics, 2000) are:

l Cancers (38.3 per cent).

l Diseases of the circulatory system (36.8%).

In both these cases – and in most other cases of death between ages 55 and 75 – the individual will have been aware of “changing information about their health”, as HMRC puts it. At some point before their death (even if this is only a day or two), they will have a reasonable belief that “their life expectancy may be significantly curtailed”.

In contrast, deaths by “accident and adverse effects” (source: deaths in England and Wales, Office for National Statistics, 2000) make up only 1.3 per cent of deaths between ages 55 and 75.

When the s32 member is aware of any adverse change in their health, they ought to vest their unvested s32 segments and draw maximum income from them or accept that the unvested segments will probably be subject to IHT.

Through forced vesting of all the remaining segments, this puts segmented s32 members into exactly the same position as those people with tax-free cash above 25 per cent of their fund who had to take all their cash at once, for example, executive pension plan members.

After vesting all the remaining unvested segments, the whole residual fund is subject to a 35 per cent tax charge when paid out to the member’s estate.

Therefore, for the 95 per cent or more of the age 55 to 75 population who do not die suddenly of a cause beyond their awareness, segmented s32s offer nothing that an executive pension plan or other occupational money-purchase scheme cannot also offer.

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