Pension tax trap is ended

In a surprising move, the Government has reduced the extent to which HMRC can now charge inheritance tax (IHT) at 40% on private pensions. This very welcome development clarifies a muddy area of tax law and restores a valuable form of IHT planning.

Last year, I wrote about an IHT case won by HMRC in relation to pensions. The Court’s decision was unexpected and had implications for everyone with a private pension. Mrs Arnold had been diagnosed as terminally ill and although she could have drawn on her pension, she chose not to – which was quite understandable given her circumstances. However, after she died, HMRC successfully argued that IHT should be charged on the maximum value of the benefits which she could have taken under her pension on the day before she died.  Furthermore, HMRC also successfully argued that this should be calculated in such a way so as to trigger the highest possible charge to IHT.

Worryingly, the way in which HMRC presented their case meant that regardless of an individual’s circumstances, IHT could be assessed on the value of their undrawn pension. Suddenly, standard IHT planning had been turned on its head.

However, in April, buried within the Finance Act 2011, the Government brought in a law to stop this, and removed the threat of IHT on the value of pension funds. Now, regardless of your circumstances, HMRC can no longer charge IHT on the potential benefits payable to you under your pension.

There was no great fanfare. Indeed, HMRC gave more publicity to the increased income tax charge (from 35% to 55%) on the value of undrawn pension benefits if an individual dies after age 75.

So what are the implications for IHT planning?

It remains just as important to review your pension regularly.

Up to age 75, it would be more IHT efficient to spend or give away your savings and those assets which do not qualify for agricultural or business property reliefs (perhaps using a trust to defer any prospective capital gains tax liability) and not to access the value in your pension.

After age 75, your pension death benefits will be subject to a 55% income tax charge so it would be more IHT efficient to draw on this at that time.

It is still just as important that:

• any pension death benefits are payable at the pension trustees’ discretion;
• couples have placed their pension death benefits into a ‘bypass trust’; and
• you have nominated beneficiaries of any protected rights fund.

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