It is important when giving advice on Pensions that the client is aware how this sits with Inheritance Tax Planning.

Regulations concerning pensions have changed. Many of the changes concern Income Tax but the subject of Inheritance Tax (“IHT”) is something that should not be overlooked.

Pension policies where benefits have not yet been taken?

Under the new rules it is worth considering that leaving funds in a pension fund at your death could improve your Inheritance tax situation, particularly in comparison with taking out the pension where it could be subject to 40% IHT.

Would Inheritance Tax have to be paid on a payout, if you should die before pension benefits have been taken?

Generally, pension death benefits paid out – including under “Drawdown facilities” – will not be subject to Inheritance Tax in the Estate of the Scheme member where they are payable under an Occupational Pension Scheme or a “Personal Pension Scheme”.  This is provided lump sum benefits are paid out within two years of the death, or any Drawdown has commenced within that time.

Under these schemes, the Pension Scheme Administrator normally has an element of discretion as to the recipient of the Death Benefits (often backed up by a non-binding nomination or “letter of wishes”).

However, the pension benefits could be caught for Inheritance Tax in the following circumstances:

The Pension benefits have to be paid into the Estate of the pension scheme member; for example if the only “person nominated” has already died before the Scheme member; or

The pension scheme document gives the member the power to make an irrevocable “binding nomination” to direct where the proceeds will be paid.

The element of discretion will not in that case be available to the Scheme Administrator, and the death benefits will potentially attract Inheritance Tax.

What about “Retirement Annuity” Pension schemes

Lump Sum Pension benefits from “Retirement Annuity” Schemes taken out prior to 1 July 1988, and “Section 32” deferred annuity contracts are usually paid into the Estate of the pension scheme member, and will then be subject to Inheritance Tax.

What can I do if I am caught by this?

A way out of this is to set up a separate trust, perhaps using a solicitor, and the Pension Scheme death benefits would be paid into this trust.  The member would choose the trustees, and would specify their own preferred beneficiaries. The pension benefits can then be passed to the next generation free of Inheritance Tax.

If this applies to me, can I make a change at any time?

HMRC generally accept that changing the Pension Death Benefits has a nominal effect for IHT purposes if they are in good health when the transfer or assignment takes place.

If the pension scheme member dies within two years of making such a change, the Personal representatives will have to report this to HMRC on form IHT409, and IHT may become payable.


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