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Skimming off the cream

A wealthy client, who has no need for further income, faces a pension dilemma as he turns 75

We were contacted by the client as he approached his 75th birthday and forced maturity of his personal pension.

Independently wealthy and enjoying a considerable, secure income from a variety of sources, our client saw the need to take his pension benefits as a frustrating imposition rather than a valuable additional source of income.

The tax-free cash would enter his already considerable estate, exacerbating a potential inheritance tax problem, while the balance of his pension fund would be lost to the client and his family for ever in exchange for an income that he did not need and which would be taxed at 40 per cent.

The client’s requirements were quite straightforward. He neither wanted nor needed the income. He simply wanted to ensure that, upon his death, his wife and children would receive the biggest possible tax-free lump sum.

While there were some interesting alternatives which might have been relevant – Canada Life’s annuity growth account and L&C Pensions’ open annuity, for example – the personal pension fund, at 131,403 including potential tax-free cash, was really too small to be acceptable to the providers of these more sophisticated arrangements. Furthermore, the client was keen to avoid complicated pension arrangements that would require regular reviews.

As the client enjoyed excellent health, we suggested a more creative solution. First, he could take the maximum permitted tax-free cash of 32,850, which he could distribute to his wife and children or place in one of his existing family settlements set up for IHT planning purposes. The balance of the fund, 98,553, could then be used to buy a conventional, guar- anteed pension annuity. The annuity would be on a single-life, level basis, payable annually in advance, without a minimum guaranteed payment period, ceasing on his death. Taking the open market option, Prudential offered the best terms, giving a gross annual income of 9,564.24.

The final stage was the use of the income. Assuming an ongoing income tax rate of 40 per cent, the pension annuity would provide a lifetime net income of 5,738.54. This income would be wholly and demonstrably surplus to his requirements and gifting it away would have material effect on his standard of living. We therefore recommended that the net income should be used to fund a whole-of-life insurance policy written on his life only, on a sustainable, standard sum assured basis, with premiums paid annually.

Having researched the market, the best terms were offered by Prudential International, which quoted a sum assured of 96,616. The policy would be placed in an IHT-efficient trust, excluding our client as a potential beneficiary and instead naming his spouse and children as beneficiaries.

The strategy is quite simple. Had our client died on the day prior to his 75th birthday, the 131,403 pension fund would have become liable to IHT. Once all the arrange- ments were in place, his beneficiaries would receive 32,850 immediately. This would be treated as a potentially-exempt transfer and after seven years it would fall out of his estate.

In the meantime, the pension annuity income would fund his life insurance policy for the rest of his life. Upon his death, the pension income would cease but the life policy would pay the 96,616 sum assured to his beneficiaries. As this would arise outside his estate, no IHT would be payable.

In short, we turned the 131,403 that his beneficia- ries would have received into 129,466, the majority of it being IHT-free at any point and all of it falling outside his estate in seven years. The cost to the client was effectively nil. There was no impact on his income tax situation and he is spending income that, prior to his 75th birthday, he was not receiving anyway.

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