PENSION REFORM 2014/15
Synopsis: Greater ( if not complete) clarity on whether funds designated to drawdown remaining on the death of a Member , beneficiary , successor etc. will be subject to IHT on death.
Over the past few weeks there has been uncertainty as to whether the pension funds of an individual who is taking income drawdown will be free of IHT on their death. Similar uncertainty exists in relation to drawdown funds held for beneficiaries, nominees and successors.
HMRC have now provided Technical Connection with some further clarification of the position.
In Finance Act 2011, the 55% recovery charge was introduced. This applied to pension funds of people who died either
– owning crystallised pension funds (on death at any age) or
– owning uncrystallised funds where they were aged 75 or over on death
At the same time an exemption was introduced in section 12 (2ZA) of the IHT Act to remove an inheritance tax charge under the ‘omission to exercise a right’ rules in section 3(3) IHT Act. The offending “omission” being the omission to actually draw funds that had been designated to drawdown.
Introduction of Flexi-Access Pensions
As part of the flexi – access pensions “revolution”, the coalition Government introduced provisions which made the taxation of death benefits more favourable. In effect, if the member died below age 75 no income tax liability would arise irrespective of whether benefits were taken as a lump sum or left into drawdown. In the event of death at 75 or over, a 45% tax charge would arise on lump sum payments with drawdown payments being taxed as income of the recipient.
It was assumed that under the new regime inheritance tax would not be an issue. However, some commentators queried this analysis stating that section 3(3) could still apply in cases where the member died having designated his pension fund to drawdown. This was on the basis that the exemption in section 12(2ZA) only applied to the member’s right to elect to crystallise the plan and so draw benefits. The exemption did not apply to the member’s rights to draw the funds having gone into drawdown i.e. where the funds had already been designated to drawdown but just hadn’t been fully drawn at the point of death.
Joe is age 73 and dies owning an uncrystallised pension plan. Whilst technically he has omitted to exercise a right in that he could have crystallised his plan and taken benefits, section 12 (2ZA) will provide an exemption from such a change.
Bert is aged 75. On 1 May 2015, he crystallised his pension plan with his original pension provider. He took his PCLS but took no other benefits. He dies on 1 August 2015. The exemption in section 12(2ZA) will not apply because he is already in income drawdown and so section 3(3) can possibly apply to the invested funds (but see below).
HMRC’s stance on the position
HMRC agree with this interpretation of section 12(2ZA). In other words, notwithstanding the introduction of the exemption in section 12(2ZA) of IHTA by Finance Act 2011, section 3(3) can still potentially apply to tax funds held in drawdown on an individual’s death and therefore those undrawn benefits can be subject to IHT.
However they have also stated that their existing guidance confirms that a charge under section 3(3) will be considered only where there is evidence that the member’s intention in failing to actually draw retirement benefits was to benefit others on death rather than to benefit the member. In practice, they say, this means that a claim would only arise where the member was in ill-health at the time he took a decision to: ·
• designate funds for drawdown, or
• change the established pattern of withdrawals from drawdown resulting in reduced benefits being taken by the member.
HMRC has confirmed that a member would be accepted as having been in normal health in the event that they survive for two years from the relevant decision.
So what happens now?
We have been informed by HMRC that it was never intended that section 3(3) should apply to any funds designated for drawdown but undrawn at the date of death. HMRC has been made aware that technically a charge to inheritance tax can arise in these circumstances.
HMRC make the point that the circumstances in which a possible section 3(3) charge could actually arise are extremely limited. In practice HMRC have not come across any cases where the charge has arisen to date.
They are however considering the position in the light of the pension changes in April 2015 and whether a legislative change should be made to put the position beyond doubt. Any legislative change could apply retrospectively back to the introduction of section 12(2ZA) IHTA 1984 in 2011.
Whilst this news is very comforting, clearly an essentially unsatisfactory position exists. The position is that technically, the crystallised funds of some individuals who die (having been motivated to omit to exercise their right to actually draw benefits by virtue of their serious ill health) may be subject to inheritance tax despite this not being the intention of the Government. We would hope to see the position clarified by the introduction of revised legislation and from the correspondence we have had, HMRC do not seem averse to doing so in order to put the position beyond doubt.
We are still in discussion with HMRC over certain points of interpretation on the IHT treatment of pension funds and will report further in due course. On balance though we believe the tone of the responses we have received from HMRC to be essentially reassuring.
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