One of the most attractive features of a personal or company money purchase (or Defined Contribution) pension scheme is the protective shield that these schemes provide against the taxman and in particular Inheritance Tax (IHT).
It is commonly assumed that because the pension scheme is in Trust, and the beneficiaries are discretionary, the proceeds on the death of the policyholder can pass easily to the nominated beneficiaries without liability to tax.
This is normally the case but there are circumstances where HMRC can open their IHT file and seek to tax these payments.
The first instance where this is possible is in the event of a policyholder dying after age 75 but where the benefits are not paid within 2 years of the date of death. This is a tax that can easily be avoided by ensuring the pension benefits are dealt with in a timely fashion after the member’s death.
The second instance can be a trap for those with impaired life expectancy. It is quite normal for those in this unfortunate position to seek ways of ordering their financial affairs to maximise the outcome for their family and wider beneficiaries. In such circumstances, it might seem logical and efficient to ‘tidy up’ ones existing pension schemes by transferring them into a single, low-cost flexible arrangement, with new and clear instructions as to where the funds are to be distributed on the death of the policy holder.
Although the monies will be transferred from one pension scheme to another, where the same rules apply, HMRC will take a different view if death occurs within 2 years of the transfer.
From HMRC’s perspective the policyholder is surrendering his rights under one scheme in return for the rights in the new scheme. At this point HMRC wants to establish what change there has been in values as far as the estate is concerned, and will test the difference between the open market value of the death benefits that could have been directed to the estate and the lifetime rights that make up the receiving scheme. For Money Purchase schemes there is clearly less value in the death benefits for a healthy policyholder in the transfer value because a normal life expectancy would cause the fund to deplete over time, leaving little for the beneficiaries. Therefore the transfer of value is minimal, and negates the possibility of an IHT claim.
However, where a policyholder was knowingly in ill health at the time of transfer, there is much less chance of the pot being exhausted, and therefore there is a significant transfer of value, leading to an IHT claim.
HMRC compares what would have normally been expected to the estate via withdrawals (net of tax) over time with what is denied to the estate by leaving the funds in situ until the date of death.
The actual calculation is quite complex but for a transferred fund of £500,000 it would produce a claim in the region of £150,000. It is often assumed that any death benefit payable to a spouse or civil partner would be exempt IHT, but in these circumstances it would not be the case. As ever, it is essential to be aware of these wider considerations when planning at retirement.
For UK nationals living in Italy this is an area that needs extra attention, as the tax rules applying to the death benefits from pension schemes can result in additional taxes. These taxes can be avoided, by carefully constructing the most advantageous pension arrangements when retiring in Italy. There are additional, potential tax advantages available to UK nationals living in Europe and specialist financial advice can deliver significant gains. Whilst Brexit remains unsettled there is still a window of opportunity for ex-pats to benefit from a review of their existing UK pension schemes.
This article has been written by Dominic Scoffield who is a UK Chartered Financial Planner And Senior Retirement Consultant at Unity Financial Partners.
To arrange a confidential review of your UK pension arrangements with Dominic and assess their suitability for you as an Italian resident, please send an email to email@example.com quoting BII5 in the subject bar or contact us at:
Unity Financial Partners
Viale Shakespeare 47
Tel: 06 45429867