Tracy, 61, divorced Peter, 63, in January 2014. In 2016 she found out she had an incurable disease and decided she wanted to transfer her pension benefits into a personal pension scheme to avoid her former husband benefiting from it after she passed away.
Tracy died later in 2016 without crystallising her personal pension benefits. HM Revenue & Customs (HMRC) argued that, because she knew she was terminally ill when she made the transfer, it should be treated as a chargeable lifetime transfer.
In addition, because she had not drawn down any personal pension benefits, HMRC claimed both acts had been deliberately used to reduce the value of her estate for inheritance tax (IHT) purposes and it applied an IHT charge. This will reduce what her sons’ stand to benefit from her estate.
As Tracy died when she was 61, in normal circumstances her death benefits would have allowed her uncrystallised funds to be paid to any beneficiary completely tax-free as a lump sum, annuity or as a drawdown pension. However, because she had transferred the pension in the knowledge she was ill, HMRC, due to winning a previous court case involving a lady called Mrs Staveley, have precedent so can apply an IHT charge to her transfer.
There are some instances in which, even with the possibility of IHT, a transfer might still be beneficial. For example if there was no (or a very limited) death benefit payable from the member’s current scheme and a much higher one (even after taking account of any IHT charge) payable from the receiving scheme.
While there was little Tracy could do about the IHT on the pension, she should have made sure her expression of wishes was up to date (and regularly reviewed) and worded in such a way to ensure maximum flexibility for the beneficiaries. Similarly, making sure her will was updated can save a huge amount of time and money.
Ultimately the best way to reduce Tracy’s IHT bill would be to take a holistic approach to her estate prior to her death. This would mean implementing tax mitigation strategies involving her other assets in a bid to lower the overall amount of IHT paid on the entirety of her estate.
Allow enough time
In most circumstances the best way for Tracy to reduce her IHT bill is to gift to beneficiaries during her lifetime. However, she would not survive the seven years necessary to make the gift exempt from inheritance tax.
There is a tapering effect on the IHT liable to be paid, meaning the amount due will reduce depending on how long ago the gift was made. In Tracy’s case, she would not live long enough to benefit from this tapering effect.
The key is to act while in good health. Get your plan in place before it is too late. Tracy should have acted as soon as her divorce occurred.
Advisers should keep their client’s pension fund in a plan that is up to date and offers the latest flexibility (with the right nomination). And ensure their other assets are well structured with the use of gifting and trusts as necessary to mitigate against any tax.
Ian Browne is head of retirement proposition marketing at Old Mutual Wealth