Financial advisers are often called upon to impart recommendations on a variety of pension transfers when clients are in poor health. This could be in the form of defined benefit (DB) pension transfers or transfers where safeguarded benefits are involved, such as guaranteed annuity rates.
Even pension switches with a view to access flexible benefits could incur inheritance tax (IHT) if the client dies within two years of the switch.
Without doubt, for clients in poor health, and particularly where DB pensions are involved, death benefits play an integral factor in the decision to transfer out.
Case study: Parry and others v HMRC
Such circumstances were highlighted by the Court of Appeal’s verdict of the Parry and others v HMRC (2018) case that took the industry by surprise.
The UK’s financial advisory community was enthralled by the case, particularly professionals that specialise in pension transfers and switches between UK pensions.
Perhaps the most-intriguing outcome prevailed as the judges failed to agree on the exact reasons why IHT should apply in this case, despite an agreement it should apply for both item 1 (transfer from the Section 32 scheme to a personal pension plan) and item 2 (Mrs Staveley’s omission to withdraw an income from the personal pension plan).
It is important to highlight that under the Pension Act 2011 and from 6 April 2012, IHT charges for ‘omissions’ to take pension benefits in relation to a UK pension scheme will no longer apply. Mrs Staveley was not able to benefit from this as she died in 2005.
When the client is in poor health a transfer between two pension schemes is likely to be a transfer of value under the Section 3 para (3) Inheritance Tax Act (IHTA) 1984.
This is because of the client’s failure to exercise a right, ie he could have exercised a right to nominate their estate to receive the death benefits. By failing to do this, their estate is reduced, and IHT should apply on the amount that reduced the value of the estate.
In these cases, section 10 of the IHTA 1984 is equally important and particularly where there may be an intention not to confer a gratuitous benefit. In this instance, IHT should not apply (see below).
Gratuitous benefit
In the Parry and others v HMRC case, Mrs Staveley’s health had been defined as terminally ill. Upon her impending death, she had prior sought to ensure that no pension benefits would fall into the hands of her ex-husband.
Under the pre-A day pension rules (introduced 6 April 2006), any surplus in pension benefits would have been previously paid into the company owned by her former husband.
Given their acrimonious divorce, Mrs Staveley wanted to take every precaution to ensure this wouldn’t happen and that her ex-husband would not benefit.
As Mrs Staveley realised she would not survive beyond 6 April 2006, when the new pension rules came into effect and new death benefits pension rules also applied, she decided to transfer her pension benefits from the Section 32 scheme to a personal pension plan.
When arriving to a conclusion, the Court of Appeal judges would have considered whether Mrs Staveley’s intention was to confer a gratuitous benefit, as per Section 10 IHTA 1984.
To do this, they looked at what happened after the transfer with the view that the transaction should be considered together with the “associated operations”, as per Lord Justice Nevey’s verdict statement.
In this case, Mrs Staveley’s decision not to take retirement benefits led to the conclusion there was an intention to confer a gratuitous benefit to her children, too, and as a result IHT should apply on Item 1.
“The fact that the transfer to the PPP was not intended of itself to confer a gratuitous benefit (because Mrs Staveley was not intending to improve her sons’ position by it) cannot without more prevent it from having been a relevant ‘associated operation’.
“The [First Tier Tribunal] was, in my view, mistaken in considering there was ‘no intent linking [the omission to take pension benefits and the transfer to the PPP]’,” said Nevey.
Inheritance Tax Act 1984, section 10
Dispositions not intended to confer gratuitous benefit.
(1) A disposition is not a transfer of value if it is shown it was not intended, and was not made in a transaction intended, to confer any gratuitous benefit on any person and either –
(a) that it was made in a transaction at arm’s length between persons not connected with each other, or
(b) that it was such as might be expected to be made in a transaction at arm’s length between persons not connected with each other…
(3) In this section – ‘disposition’ includes anything treated as a disposition by virtue of section 3(3); ‘transaction’ includes a series of transactions and any associated operations.
Married clients
This recent case has undoubtedly raised many questions. In cases where clients are terminally ill, I agree with HMRC that there can be no other reason to transfer unless with a view to confer a ‘gratuitous benefit’, ie to increase death benefits for both the client’s spouse and their children.
That in itself does not mean a transfer should not be recommended. For married clients, Section 18(1) IHTA 1984 exemption may still apply. Applicable circumstances would require the value transferred be attributed to their spouse’s estate and, if not, the spouse’s estate must be increased
by that value.
As a result, for the spouse exemption to apply the spouse must receive the death benefit as a lump sum.
A nominee flexi-drawdown pension, received by the spouse, would not benefit the IHT exemption as it would not increase the value of the spouse’s estate.
In this case, the nil rate band (NRB) would be applicable. In many cases, the NRB would be sufficient to cover the transfer of value, as calculated by the Government Actuarial Department based on the illness the client suffered from.
Another option may be to advise the client to nominate their estate to receive the death benefits from the personal pension. In this case, both the spouse exemption and the NRB will apply.
In the case of clients in poor health but not terminally ill, a transfer from a DB scheme should not be intended to confer a gratuitous benefit. Here, advisers must show caution as they draft suitability reports.
It is important to indicate higher retirement benefits as the singular reason to transfer, and not death benefits.
Once the transfer proceeds, the client must start withdrawing higher retirement benefits, as any omission to do it will indicate the intention to confer a gratuitous benefit.
In the event that a client survives two years beyond the transfer, an alternative retirement planning strategy may apply.
This may include stopping retirement benefits or the client starting an expenditure on assets that would otherwise be assessed for IHT on death.
Where all advisers may not be accustomed to such complexities or issues, it is vital to stress that should a client be healthy when the transfer actually takes place, the value of the transfer for IHT purposes would be nil.
As a result, no IHT would apply in the event of a client passing unexpectedly in the course of the next two years. The executors or personal representatives of a client’s will and estate must still report the transfer or pension switch on the IHT409 (form).
Further reading:
New rules for UK pension transfers
By Eugen Neagu, head of financial planning, Montfort
