SIPP’s place in an adviser’s inheritance tax toolkit
Pension rights are generally exempt from inheritance tax. The Government has enhanced this exemption over a number of years and following the succession planning opportunities presented by the April 2015 pension reforms, we highlight why a SIPP is a highly useful addition to an adviser’s inheritance tax toolkit.
One of the several tax advantages of saving into a pension is that the benefits an individual accrues are generally exempt from inheritance tax (IHT) on their death. Although there are limits to this exemption, the direction of travel since 2011 has been to broaden the circumstances in which it applies so that future generations can benefit (or continue to benefit) from those pension savings without suffering a 40 per cent tax charge.
General powers over death benefits
Most trust-based pension scheme members (e.g. Hornbuckle SIPPs) cannot make a binding decision about how and to whom their remaining pension savings are paid on their death. They can give the pension provider or trustees a non-binding nomination (an ‘expression of wish’) of what they would like to happen on their death, but ultimately they have no power to insist their wishes are adhered to. As such, their pension savings do not form part of their estate and are not subject to IHT.
Where – exceptionally – this is not the case, and the member can make a binding nomination, they are regarded for IHT purposes as possessing the general power to dispose of the ‘property’ (i.e. their pension savings) and they will form part of their estate.
This principle applies equally in cases where the member assigns the benefits in their pension to a discretionary trust of which the member or their estate can be appointed a beneficiary. Most pension providers prohibit this type of assignment so that an IHT liability does not arise.
Transfers of value
In IHT cases generally there are rules to prevent individuals in poor health transferring assets to others with the specific intention of reducing their IHT bill. Where such a transaction occurs and the individual dies within two years, it may be viewed by HMRC as a ‘transfer of value’ and has the potential to give rise to an IHT liability.
In a pensions context, issues used to arise where someone could choose to access their pension savings but had chosen not to do so and died within two years of that decision. Such a decision was regarded as an ‘omission to exercise a right’ over property under section 3(3) of the Inheritance Tax Act 1984, and HMRC could seek to recover IHT on the value of the ‘right’ that had not been exercised e.g. the right to draw a tax-free lump sum.
This situation was amended by the Finance Act 2011 so that from 6 April 2012 the omission to access pension savings, even if it occurred immediately prior to an individual dying, would not give rise to an IHT liability.
The Finance Bill 2016 contains some further draft amendments to the rules that will mean that funds designated to provide a drawdown pension, but which remain undrawn on an individual’s death, will not form part of their estate for IHT purposes. The amendments will have retrospective effect, so that they will apply in relation to flexi-access drawdown arrangements from 6 April 2015 and to other pension arrangements from 6 April 2011.
There are some exceptions to these rules in the case of certain transfers made during a pension member’s lifetime.
A somewhat counterintuitive example arises in the case of transferring benefits from one registered pension scheme to another. HMRC’s position is that at the point of transfer the member could decide to assign their pension benefits to their estate, and that where they do not do so this reduces the value of their estate and could be regarded as a transfer of value.
Another example is where the member irrevocably assigns their pension benefits to a discretionary trust. Most pension providers do not permit this type of assignment, since only non-binding nominations can be given as explained above.
In either of these cases a transfer of value potentially giving rise to an IHT liability can occur where the member dies within two years of the event in question.
IHT charges can occur where an individual changes the pattern of their pension contributions while in ill-health.
For example, if a member starts paying significant additional contributions into their own pension scheme(s) within two years of their death, HMRC may regard that as a transfer of value that could give rise to an IHT charge.
This issue may affect contributions paid by an individual for someone else’s benefit, for example where contributions are paid into a pension plan for a child or grandchild. There are, however, some specific exemptions for contributions that are:
- paid into a pension for the benefit of a spouse or civil partner
- paid by way of the individual’s normal expenditure out of income
- paid by an employer into an employee’s pension scheme.
Some tips for advisers
The various IHT exemptions, together with the flexibility of death benefit treatment introduced under the April 2015 pension reforms, suggest some useful principles for advisers to consider when advising on estate planning:
- Clients in normal health can generally continue to pay pension contributions into their own pension plans without risking an IHT liability. Even those with a reduced life expectancy can continue to do so, but should carefully consider the consequences, in terms of tax, of any additional contributions which may be substantial.
- Clients in ill-health may have to be careful of the IHT implications of pension transfers, or of any assignment of their pension benefits into trust.
- Because of the IHT treatment of accumulated pension benefits, those with significant taxable estates might consider funding their living expenses out of their non-pension assets first. Given the reforms to pension death benefits from April 2015 pension savings can now be passed down to a broader variety of beneficiaries and, if the member dies before age 75, the savings are normally passed down tax-free.
- An additional way of passing wealth down the generations is to make pension contributions on behalf of children or grandchildren. Any significant contributions paid by individuals in ill-health risk giving rise to an IHT charge, but regular contributions paid out of the individual’s income are normally exempt.
The confluence of gradual change to the inheritance tax rules and the flexibility provided by pensions freedom has therefore made a SIPP an indispensable part of an adviser’s tax planning toolkit.
If you’d like further information on why a SIPP an indispensable part of an adviser’s tax planning toolkit, please contact our Business Development Managers via an email at: firstname.lastname@example.org