Inheritance Tax (IHT) can affect property, money and possessions. Your pension is normally free of IHT, unlike many other investments. It is not part of your taxable estate.
We say normally as a tax case has just finished concerning one of the times someone’s pension can be subject to IHT.
What is the case?
The case involved a pension which was transferred after an acrimonious divorce. The death benefits from this pension were then assigned to the children. The person who had transferred this pension then died a few weeks later.
Because this person was terminally ill, HM Revenue & Customs treated the transfer as a “chargeable lifetime transfer” followed by an “omission to act” as she did not draw any benefits. Because of this, they applied IHT to it.
HMRC argued the two actions were linked and designed to reduce the value of her estate for IHT purposes. The defence was there was no such intention.
This case has divided the courts. The Court of Appeal ruled in favour of HMRC in June 2018. It decided it was right to apply IHT to the transfer as well as on the omission to draw any benefits after two tribunals beforehand had found otherwise.
The Supreme Court this week partially upheld the Court of Appeal’s judgement. The court said IHT could be charged on the omission, as it was the main cause of increasing her children’s share of her estate. It, however, decided IHT could not be charged on the transfer itself as it “had not been motivated by any intention to improve the sons’ position”. This was because the death benefits could have been changed without transferring the plan.
Does deferring retirement cause an IHT charge?
Before 6 April 2012, claims to IHT on pension funds could potentially occur where, for example:
- retirement was deferred
- phased retirement was undertaken
- income withdrawal was entered instead of buying an annuity
These involved omissions to take retirement benefits. If any took place whilst in ill health and the person in question died within two years was done whilst in ill-health HMRC would seek to add an amount to the estate for IHT purposes.
The government brought about a change in the law (Finance Act 2011) which stopped this. As the case mentioned previously involved a death that took place before this change, it was caught by IHT.
What scenarios are there where my pension could be caught by IHT?
Some older pensions direct death benefits straight into your estate. If you transfer them while in ill health and die within two years, it is highly likely HMRC will look to charge IHT on them. This is where HMRC could say there was a loss to the estate by transferring.
Another scenario is where someone dies before their 75th birthday. In this case, the pension must pay any lump sum death benefit payments within two years from being notified of the death of the individual. If not, they could be subject to IHT.