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Why Your Pension May Be Subject to Inheritance Tax – and How to Avoid It

One of the features of modern pension plans is the ability to leave any remaining pension fund to your family on your death, providing a flexible inheritance for families. Many people have already transferred their pension entitlements to take advantage of this, in the knowledge that they will be able to pass on some or all of the value of their pension to their children. However, a recent court case has led to some people having to pay Inheritance Tax on their pension. How might this arise?

The funds transferred within a pension do not usually form part of your estate for Inheritance Tax (IHT) purposes, and therefore are not subject to tax. For this reason, it is not uncommon for our clients to discover that their pension fund is likely to be the most sizeable asset that they leave to their children, often dwarfing their other assets which are subject to up to 40% tax.

A recent ruling by the Court of Appeal may encourage people still considering whether to transfer their pension to make their decision sooner rather than later. The case, which has become known as the ‘Staveley case’, has made an IHT charge more likely for those who transfer while in ill-health and unfortunately die within two years. It means that if you leave it too late there may be the risk of an IHT charge if your health has begun to fail.

The ‘Staveley Case’

In 2006, Mrs Staveley had transferred her pension knowing that she was in poor health. Unfortunately she died two months later. HMRC argued that the transfer constituted a gift of death benefits to her sons, at least in part. Her executors argued that the main reason behind the transfer was to prevent her ex-husband benefiting from her pensions.

The sons won their argument when the case went to a Tribunal, and later the Upper Tier Tribunal confirmed the decision which meant that no was IHT payable on the transfer.

However the tax man wasn’t happy and took the case to the Court of Appeal. The Court agreed with HMRC’s view that the transfer had indeed included a gift of death benefits to the two sons. Although the main reason had been to prevent any pension money going back to the ex-husband, it was not accepted as the ‘sole motive’. As a result, tax would indeed be payable and a large slice of the fund was due in tax.

This was a complex case which has been dragging on for 12 years, but it does establish legal principles going forward. Whilst the vast majority of people who transfer their pension whilst in normal health are unaffected by this decision, it means that anyone in failing health could face a charge to Inheritance Tax on their pension funds on their death. It therefore makes sense to transfer long before health becomes an issue, assuming that a transfer is sensible in the first place. We’ve discussed the factors involved in the transfer decision in a previous blog post, and can give you advice on this if you’re in this position.

Getting good advice in this important area is critical, due to the complexity of the decision. It’s also vital that you complete the relevant forms to ensure that your pension benefits go to the people you nominate, and that the funds are set up in a way that offers you the most flexibility whilst you draw your pension, and to your beneficiaries in the event that they inherit the funds. If there were to be a challenge by HMRC, the records of your discussions with your advisor could prove to be essential evidence in deciding the reason for making the transfer, and your state of health at the time.

It’s also really important that your decisions about your pension and what happens to it on your death dovetail in with your wider estate planning. Our experience has been that many solicitors don’t consider pension benefits when they discuss making a Will or Inheritance Tax planning, yet this could be a very significant part of what you leave behind. That’s one of the reasons why our Team includes qualified solicitors, accountants and financial planners who are able to call on each other’s expertise to ensure that our clients get effective advice. It’s an approach that has delivered great results for our clients over the last few years.

If you would like great advice on how to protect your assets for your family, or how to get the maximum value from your pension scheme, get in touch with us today and speak to one of our experts.

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