Pensions have been confirmed as the vehicle of choice for inheritance tax planning as a result of a watershed UK Supreme Court judgement.
The background to this case is the answer to the question “What steps are reasonable to stop your ex inheriting your money?”
To prevent her pension falling into the hands of her ex-husband, the late Mrs Staveley transferred her pension six weeks before her death in 2006.
In a surprising turn of events, HMRC took a startlingly different view of the transfer. It was a shocking case of evasion, undertaken to keep an unspent pension from the clutches of HM Revenue & Customs. In such circumstances, HMRC can claim that Inheritance Tax (IHT) should be applied to the transfer under the “gratuitous benefit” rules set out in the 1984 Inheritance Tax Act. These rules apply where someone knowingly in ill health has moved their pension with the sole aim of reducing the tax their estate would otherwise pay.
Following HMRC’s claims, the case has gone back and forth in the courts with three sets of judges deciding first one way then the other. Finally, the Supreme Court, the highest court in England, decided that IHT should not be applied and HMRC should let Mrs Staveley’s sons have their money.
For many years, pension providers have had to hold back a proportion of any pension transferred within two years of death, in case HMRC comes calling to collect IHT. To add to the confusion facing pension providers, trustees, and beneficiaries alike, the rate of tax applied in these cases is not 40pc as is normally the case, but a variable rate that is often a little lower.
You may be surprised to hear pensions are subject to IHT – after all, Chancellor George Osborne abolished the taxation of pensions on death in 2014?
Pensions do not suffer IHT (except for the anomaly described above) and that is why we will always tell you to use your pension as the last source of funds in retirement. Remember, unlike cash, property, and investments, a UK pension or QROPS does not count as part of your estate.
From a UK tax perspective, should you die before the age of 75 no tax is due at all – not even income tax! As is more likely, if you die after you are 75 your beneficiaries will just pay income tax at their marginal rate and according to their residency status. In the case of UK resident grandchildren, this may well be the attractive rate of 0pc, so long as they limit withdrawals to their “personal allowance” – £12,500 in this tax year. Remember if the money is not withdrawn no income tax is due.
The changes to the taxation of pensions in death is generally viewed as a major contributor to the success of the 2015 “pension freedom” reforms, which took the shackles off UK pensions and allowed total freedom. Since April 2015, once you are aged 55 or over you can withdraw and use your pension in any way you wish including:
- buying an annuity
- leaving it invested
- “drawing down” an income
- cashing it in all in one go, or in several instalments
The additional freedoms and the ability to pass residual funds down the generations largely explains why billions of pounds have left “final salary” schemes – which can’t benefit from pension freedoms – to individual pensions since 2015.
The choice to exchange the guaranteed, inflation-proof income of a final salary pension for the freedoms offered by an individual pension is not to be taken lightly. It is important to remember that once done the change cannot be undone however, with careful planning your pension does not have to die when you do and can benefit generations to come.
To find out more about how your pension can do more than provide retirement income, contact your AAM Wealth Manager or contact us today for a free financial planning consultation and get all your financial affairs in order.
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