How to avoid bringing pensions into the IHT regime

The answer is that pensions are, of course, already included in the IHT regime. Most schemes do not attract IHT charges, but in certain circumstances they can do and how and when this happens is complex and, in some cases, misunderstood.

Broadly speaking, pensions are brought into the IHT regime under the general principles for IHT, namely:

• what assets an individual has on death;
• what their estate is entitled to;
• what property they have a general power of disposal over;
• what transfers of value they may have made in the period prior. 

Pensions do benefit from an explicit exemption. Most scheme death benefits are held on discretionary trusts, which would ordinarily mean they are classed as “relevant property”, but the IHT code exempts them from the periodic and exit charges usually associated with them.

When it comes to pensions, the type of pension an individual has and what they do with it can, and does, have an impact on the IHT treatment. 

Being included within the IHT regime means pensions have their own IHT form (IHT 409). Working through the three main areas of this form allows us to better understand the circumstances in which pensions can bring about IHT charges. 

1) Payments made under a pension arrangement that continue after a death

There are two main areas here. First, there are payments of the member’s pension that have become due but had not been paid at the date of death. This could be “pension arrears” and, as they are due to the estate, they form part of it for IHT purposes. 

The second situation is “guarantee payments”, that is, the pension will be paid for a minimum period. Where the deceased dies prior to the end of the period and has control over who the guaranteed payments are made to, then the open market value of those payments is included in the estate.

HM Revenue & Customs has a calculator for working out this value. This may be moot if being paid to a spouse as the inter-spouse exemption would then apply. If the scheme has discretion over who payments are made to, then there is no value for IHT.

2) Payments of death benefits

It is essential to understand the rules governing the payment of death benefits from a pension scheme. This may require reading the trust deed and/or scheme rules or an explanation from the trustees/administrator.

If the scheme has discretion on the payment of death benefits, they do not form part of the estate for IHT purposes.

Where the estate is entitled to the benefits then these are included in the estate. An example of this can be old retirement annuity plans that have not been placed under trust.

Just recently, I saw one of these plans that was valued at more than £1mn and would make a substantial difference to the value of a person’s estate.

Some public sector additional voluntary contributions are also payable to the estate. Another example is pension plans that used to be in an occupational scheme and have been transferred into an individual's own name.

This could have been on a bulk basis when a scheme closed, or where an individual money purchase plan is assigned from the scheme to the individual when they leave employment. These should be checked if there is any doubt.

The final thing to be aware of is the “power of disposal”. If the scheme has no discretion and the member can dictate who death benefits are paid to, then this would be included in the estate.

Likewise, the construction of a scheme's rules may be such that an action of the member could result in payment being made to an estate, for example, if no expression of wish is received or an expression is rescinded then the rules may dictate the benefits are paid to the estate. 

As most pension death benefits are not chargeable to IHT, it can provide an opportunity for people in ill-health to use their pension schemes to pass value to otherwise chargeable beneficiaries without a tax charge

Some schemes do have binding nominations that are “IHT friendly”. This could be where the binding nomination is irrevocable, or only allowed when a scheme is first joined. If in doubt, it is best to check with the specific scheme.

The Nest scheme death benefit arrangements are just one example of the complexity that members can face. In this scheme, binding nominations can be changed or members can make a nomination giving trustees discretion over how death benefits are distributed.

If nothing is noted, then the benefits are paid to the estate. This means that different members of the same scheme can have different IHT positions.

3) Changes, transfers, disposals and contributions made within two years of death

As most pension death benefits are not chargeable to IHT, it can provide an opportunity for people in ill-health to use their pension schemes to pass value to otherwise chargeable beneficiaries without a tax charge. 

HMRC is on the lookout for changes to pensions made prior to death seeking potential transfers of value.  

It deems all pension transfers to be transfers of value. While a pension does not arrive back in your estate mid-transfer, you could ask for it to go to a scheme that pays to the estate on death. 

Some transfers can be exempt if it is found there is no attempt to confer a gratuitous benefit on another — for example, you were transferring to get better terms, or the retirement options you required were not payable from your existing scheme. It is a nuanced and particularly individual area and not one where you could be categorical that a transfer would not have IHT implications.

A clear transfer of value is a plan having the death benefits put under trust where they would otherwise be payable to the estate. Likewise, unusual levels of contributions into a pension, where death benefits are paid under discretion by a member or their employer, may attract scrutiny. 

Finally, and perhaps more niche is where death benefit options under a plan are amended — for example, older plans where death benefits may have been changed from return of premium to return of fund.

Broadly, if there is no evidence of ill health when the changes described above are made and they were made more than two years ago, there may not be any scrutiny. If ill health is detected at the point the changes are made, enquiries may be made.

There is no doubt pensions as intergenerational wealth transfer vehicles are very generous, and far removed from the days when pension tax reliefs were first granted, with the aim of encouraging you to save for you and your dependant's retirement.  

Bringing pensions into the relevant property regime would be fraught with complexity, and to override the general IHT principles to bring pensions into this regime would have a myriad complications.

Making pensions simpler is a good aim, but piecemeal tinkering can often lead to further complexity. If dampening their use as intergenerational planning vehicles is the desired outcome, this could perhaps be delivered most simply through a change to the taxation of benefits. 

Les Cameron is head of technical at M&G Wealth