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Supreme Court rules on pensions for savers in ill-health

written by Bella Palmer

Many savers have ditched final salary pensions in recent years due to inheritance advantages

People in ill-health have gained more leeway to move their pensions without fear of loved ones being landed with an inheritance tax bill following a key court ruling.

In a decision, the Supreme Court said the taxman could not charge on an inherited pension that was transferred less than two years before the holder's death.

Savers are typically told to beware that HMRC will look askance if they transfer out of a final salary pension while in poor health and die within two years, and could decide to levy inheritance tax.

Many savers have ditched traditionally safe and generous final salary pensions in recent years, tempted by huge transfer value offers, greater potential investment growth and inheritance advantages.

Final salary pensions usually come with death benefits for a spouse, but children and other loved ones are excluded.

However, if you have a 'defined contribution' or income drawdown pot invested in the stock market, any money left in it can be passed to who you want after your death.

Meanwhile, beneficiaries either pay no tax if the pension holder dies before age 75, or their normal income tax rate - with the money they receive added to their earnings to calculate this - if they are 75 or over.

The Supreme Court's decision involved the case of Rachel Staveley, who died of cancer in 2006.

She had transferred a pension out of a company she had co-founded with her ex-husband during their marriage, and put the money into a personal pot which her sons inherited.

However, they remain liable for inheritance tax, because Mrs Staveley had not taken any money out of her pension before she died.

Under current rules anyone with limited life expectancy who transfers their pension and then dies within two years could see their remaining defined contribution pot hit with a tax charge, says Tom Selby, senior analyst at AJ Bell. However transfers are granted an exemption provided the transfer was not meant to provide a "gratuitous benefit" to potential beneficiaries.

A gratuitous benefit is deemed to occur when a particular action is taken in relation to funds with the intention of reducing the inheritance tax applied on those funds, Selby said.

Essentially, HMRC argued Mrs Staveley’s decision to transfer her pension and bequeath the money to her children – rather than leave it in the existing scheme and allow her ex-husband to benefit – conferred a gratuitous benefit on them, he said.

Two tribunals had previously decided against HMRC, then the Court of Appeal overturned this in 2018. But the Supreme Court has now overturned that verdict and ruled the transfer should not be subject to inheritance tax, explains Selby.

He says the court decision will make it harder for HMRC to argue a transfer led to a gratuitous benefit, and the ruling is good news for savers, but the Government should remove uncertainty by exempting pensions from inheritance tax altogether.

Ian Dyall, technical manager at Tilney Group, says: The rules determining when a pension is liable to inheritance tax or when it is exempt are unnecessarily complex, and almost impossible for pension holders with no professional knowledge to understand.

He said, most pension holders are oblivious of the fact that their actions, or failure to act, can inadvertently bring their pension provisions within the clutches of the inheritance tax regime.

The Supreme Court ruling is a welcome clarification, and will reduce the occasions where inheritance tax is likely to apply, but a change in legislation in this area is needed so that pension holders are able to legitimately amend their retirement planning when necessary, without fear of creating any unexpected liabilities, Dyall said.

David Everett, partner and head of pensions research at LCP, says: In a landmark judgement handed down today, the Supreme Court has found that HMRC was wrong to seek inheritance tax on death benefits. However, the individual’s separate failure to draw any benefits from her personal pension before her death gave rise to an inheritance tax liability.

The ruling is important because following developments in recent years such as the 2015 introduction of “freedom and choice” and with the potential opportunities that arise under it to pass pension assets between generations, there has been a significant increase in those transferring their defined benefit [final salary] benefits to money purchase arrangements, typically set up as personal pensions, Everett said.

He said, many of those transferring have been close to retirement.

Everett added: The judgment does have a potential sting in the tail for those who have retired and choose to run down their non-pension assets before turning to monies within a personal pension. There is a risk that this failure to access pension assets could be regarded as a transfer of value giving rise to an inheritance tax charge.


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