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Expert commentary and analysis on developments in the marketplace together with guidance on identifying planning opportunities.
To help support your client discussions, we’ve created our new TechTalk Vodcast series that looks at a wide range of financial planning topics. Our TechTalk Vodcasts will provide the latest technical information and industry insight that you can watch online and on the go in under 10 minutes.
Techtalk Vodcast – Pensions & IHT
Hello and welcome to the first vodcast in the Scottish Widows Techtalk Vodcast series. My name is Paul Rutkowski and I am a Financial Planning Senior Manager at Scottish Widows. Hello I‘m Thomas Coughlan, Financial Planning Manager at Scottish Widows.
A client’s pension fund should, after their main residence, be their most valuable asset. As with any asset of value, it is important to understand how it will be taxed on death. In other words, how much Inheritance Tax it will attract.
This will help clients to understand how much their beneficiaries will inherit and what steps can be taken to maximise this. Thankfully, pensions are usually highly inheritance tax-efficient – often completely exempt from the tax – but there are a few traps to be aware of.
In this Vodcast we will look at why pensions usually escape Inheritance tax and the main occasions when a pension fund and contributions to it can lead to tax charges. The recent “Staveley” case has provided a mixture of clarity and confusion in one of these areas – that relating to pension transfers made whilst in ill-health.
Tom will now take you through the details.
In our first vodcast we are going to consider the occasions when a pension fund may be subject to an inheritance tax liability. This is a complex area, with some recent key developments, so keeping to date will help you ensure your clients avoid unwanted tax consequences.”
First, we are going to take a look at the rare occasion where contributions to a pension scheme can result in an inheritance tax liability.
Before we do that, it is useful to recap on the Inheritance Tax – or “IHT” – rules. The general approach to calculating someone’s IHT bill is to add up the values of all of their assets on death - excluding any exempt assets such as those left to the spouse or a charity - and charge 40% tax on the amount above the current nil-rate band of £325,000 or higher if any transferrable or residence nil-rate band is available.
The value of any assets that were given away in the seven years before death is added to the total value of the estate. This well-known rule prevents offloading of assets shortly before death to avoid IHT, but does only include any assets transferred with the intention to reduce the value of the estate. For example, a gift of £100,000 to a child is included, but assets that were ordered to be transferred to an ex-spouse following divorce are not.
Similar principles apply to making contributions to a pension scheme. Ordinarily there is no intention to reduce the value of the estate as the contributions purchase pension rights, which the member will be entitled to in retirement. For this reason, they are not transfers of value for IHT purposes. This will be the case for the vast majority of contributions. An exception arises, however, for pension savers who are in ill health.
Contributions made at this time are unlikely to increase their retirement rights. Instead, they are likely to increase the death benefits which go to a beneficiary, which means outside of the member’s estate. A member of a pension in such circumstances could, therefore, make substantial contributions with the intention of reducing the value of their estate.
HMRC’s standard approach is to look at contributions made within 2 years of death and determine if they were made at a time when the member was aware of limited life expectancy. Contributions that are simply a continuation of existing arrangements in place for more than two years before death should be ignored. Other contributions may be included within the estate.
It should be noted that the two-year period is a rule of thumb to assist HMRC in determining whether a member was aware of ill health when they made a contribution, so if a pension scheme member dies within two years of making contributions but was not aware of a life-limiting illness at that time, it is unlikely HMRC will consider them.
That covers the member’s own contributions, but what about contributions to someone else’s pension? These should accrue outside of the estate of the member, so if they are not covered by an exemption, such as the annual or normal expenditure exemption, then there is the potential for them to be included in the contributor’s estate for IHT purposes.
Having dealt with pension contributions, there are three further situations where pension benefits can be included in the member’s IHT estate.
1) The first is the straightforward payment of death benefits to the member’s estate. Some older style pensions, such as Retirement Annuity Contracts, operate in this way. If the policyholder had not assigned death benefits to a trust then the default position is that the death benefit is paid to their estate when the scheme is notified of their death. The lump sum death benefit is then included with other assets when calculating IHT.
If the death benefits were assigned to trust and the member dies within two years this could also lead to the death benefits being included within the estate.
2) The second is the slightly less straightforward situation where the member can bind the scheme to pay death benefits to a specific person. Many schemes don’t operate in this way as they pay death benefits under a discretionary rule, allowing the member to make a non-binding nomination of beneficiary to indicate whom they would like to benefit. Schemes that give members an unqualified right to bind them to pay to a certain person can result in the death benefits being included in the member’s estate on death, even if they are held under a discretionary trust.
If, instead of this right existing immediately before death, a binding nomination was made this could lead to IHT consequences. Again, for a transfer of value to be included within the estate an intention to reduce the value of the estate needs to be established. This translates to HMRC being able to show that the member was aware of a terminal illness when the binding nomination was made.
Any other assignment of death benefits during the scheme member’s lifetime will not have IHT consequences if it was made whilst in good health.
3) The third situation covers the highly topical issue of a transfer between schemes whilst in ill-health. This is arguably the most complex area of the IHT treatment of pension schemes.
Let’s look at HMRC’s guidance first.
The Inheritance Tax Manual states that when a pension scheme member exercises their right to transfer their benefits from one scheme to another, there can be a loss to the estate and, therefore, an IHT charge.
When a member transfers, they give up their rights in one scheme in exchange for rights in another. Potential for an IHT charge exists not because the pension fund re-joins the member’s estate, but because the member regains the right to decide to whom death benefits are paid and this could lead to a direction by the member that they should now be included in the estate. Because the member could direct payment to their own estate, directing it elsewhere can create a loss to the estate – which HMRC can deem to be a chargeable lifetime transfer for IHT purposes, made at the point where benefits are transferred between pension schemes.
Whilst the scheme member is in good health at the point of transfer, the value of death benefits is nominal. If they are in ill-health, however, the loss to the estate could be substantial. Again, HMRC investigate transfers made within two years of death.
The most recent judgement in the “Staveley” case by the Court of Appeal confirms this approach. This long-running case is not done yet though, after being scheduled to be heard in the Supreme Court in 2020.
The case relates to the death of Mrs Staveley in 2006, who died one month after transferring benefits from a section 32 policy to a personal pension. To briefly summarise the case, Mrs Staveley held benefits within a section 32 which, under pre-A-day rules might have resulted in excess benefits being returned to her former employer, who just happened to be her ex-husband. Her reason for transferring, therefore, was not solely to increase the death benefits available to her beneficiaries but partly to ensure her ex-husband did not receive any benefit. The Court of Appeal disagreed that this meant there would be no IHT consequences, arguing that under the associated operations provisions – in other words looking at all the different transactions as a whole – there was a loss to the estate.
As with any case, there with specific factors at play that will not apply to many transfers and some legislation that applied at that time is no longer relevant. The same conclusions, therefore, cannot be uniformly applied to all transfers between schemes made by members in ill-health.
What can be said is that transfers made by pension scheme members whilst in ill-health have the potential to be included within the death estate and advice should be given on the assumption that death within two years will result in those rights forming part of the estate. This may not lead to an increased IHT charge, for example if the deemed value of the chargeable lifetime transfer in respect of the death benefits is within the member’s IHT nil rate band, and the member’s actual IHT estate is being left to a spouse.
Pensions represent a highly IHT-efficient savings vehicle, in most cases enabling scheme members to avoid the tax entirely on all of their benefits, including those paid to their beneficiaries on death. There are, however, a number of traps to be wary of when advising members who are in ill-health. Taking steps to ensure nominations are kept up to date, trust arrangements are in place for older style scheme, and transfers between schemes and lifetime transfers of death benefits are done when members are in good health can help scheme members to avoid these pitfalls.
Thank you – that concludes this Vodcast on Pensions and Inheritance Tax. If you’d like further information, please speak to your dedicated Scottish Widows contact. Or please visit the Scottish Widows Adviser Extranet website for our full range of technical resources, including Techtalk, MasterClasses and CPD Modules.
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Pensions & internationally mobile staff
Hello, welcome to the second vodcast in the Scottish Widows Techtalk Vodcast series. My name is Paul Rutkowski and I am Senior Manager, Financial Planning at Scottish Widows. And I am Bernadette Lewis, Financial Planning Manager also at Scottish Widows.
As an industry-leading workplace pension provider, we often get asked for guidance when staff are seconded overseas, or are moving to another country. Most of the same considerations apply to our individual pensions customers.
From a UK tax perspective, ongoing employer contributions are possible, but the rules for member contributions are a little more restrictive.
As well as explaining the key tax relief and contribution limits, this session will also provide brief reminders about related issues including overseas tax, scheme rules and transfers.
And now I am going to handover to Bernadette.
In this vodcast we are going to be considering when it’s possible for members of UK pension schemes to continue contributing after they have moved abroad. We’ll be focussing on the UK tax aspects – but will also be providing you with some reminders of other factors for you to consider.
In this first slide and throughout this session when we refer to someone being non-UK resident, this means for tax purposes, as defined in the UK’s statutory residence test.
Even if a UK pension scheme member is non-UK resident, they still have to comply with the normal annual and lifetime allowance limits.
They might continue to get tax relief on member contributions to an existing pension after they become non-UK resident. But this is subject to two main conditions.
Firstly, HMRC rules state that they need to have been UK resident when they initially joined the pension scheme.
Secondly, their scheme needs to use ‘relief at source’. That’s where members pay contributions net of basic rate tax, and the provider adds this tax relief when it receives the payments. This applies mainly to group, individual and self-invested personal pensions plus stakeholder plans.
Someone who joins a ‘relief at source’ scheme while they are UK resident, but then subsequently become non-resident, can continue to make tax-relievable member contributions of up to £3,600 gross per tax year to their existing scheme. That’s £2,880 net of basic rate tax.
They can do this for up to five consecutive tax years of non-UK residence, starting with the first complete tax year that they’re non-resident.
Member contributions may have to stop if they remain non-UK resident for over five tax years. That’s unless their scheme is able to accept non-tax relievable member contributions.
However, some non-resident members won’t be able to get any tax relief on their contributions.
This applies if they were non-UK resident when they first joined a UK pension.
Or if they become non-UK resident and they’re in a scheme that doesn’t offer ‘relief at source’. This applies to most trust-based occupational pension schemes.
In this slide, we’ll be looking at an example – just considering UK tax rules. Maya joined her employer’s group personal pension in July 2009, when she was UK resident.
She was seconded overseas in August 2011, initially for four years. After her employer extended her overseas posting, she didn’t return to live and work in the UK until December 2019.
Under the statutory residence test, Maya was actually non-UK resident for tax purposes from the start of the 2012/13 tax year to the end of the 2018/19 tax year.
So, if she had relevant UK earnings over £3,600 in 2011/12 and 2019/20 – the tax years in which she actually left and returned to the UK – she could get tax relief on member contributions of up to 100% of those earnings for those tax years.
For 2012/13 to 2016/17 – the first five tax years she was non-UK resident – Maya could continue to get basic rate tax relief on contributions to her existing GPP of up to £3,600 gross each tax year.
For 2017/18 and 2018/19 she wasn’t eligible for tax relief on member contributions to any UK pensions.
The rules are much simpler for employer pension contributions. There are no HMRC monetary or time limits on employer contributions for their non-UK resident employees.
The employer benefits from UK tax relief on its pension contributions in the usual way. That is, the contributions are deductible as business expenses so long as they meet the ‘wholly and exclusively for a business purpose’ test.
Some employers might consider offering a salary sacrifice to bypass the £3,600 for five years limit on tax-relievable member contributions. That works both in terms of UK tax and pension legislation.
But bear in mind that the employee will be subject to another country’s tax and pension rules. Anyone considering this route should seek specialist tax advice, which we always recommend for overseas resident members of UK pension schemes regardless. This guidance also applies to those who are dual resident for tax purposes.
The member’s country of tax residency will treat their UK pension as an overseas scheme in terms of its own legislation. So, the member needs to comply with any local tax rules relating to making member contributions or benefitting from employer contributions to their UK scheme.
As well as tax rules, there are some other considerations.
Each UK pension scheme has its own rules for deciding who it will accept as a member. Some non-UK residents and/ or to people who aren’t actually living in the UK will not be offered membership at the outset. Or a scheme might limit an existing member’s options if their tax or actual residence status changes.
Some employers have automatic enrolment duties towards workers who aren’t UK resident for tax purposes or who aren’t living in the UK. If this creates difficulties in finding a scheme that will accept them, NEST has a public service obligation to provide automatic enrolment solutions.
Any members who want to transfer their pensions to or from an overseas scheme will almost certainly need specialist advice.
Transfers from UK schemes that don’t go into a QROPS – a qualifying recognised overseas pension scheme – face a 55% unauthorised payments charges.
In addition, transferring to a QROPS triggers a BCE 8 – or, benefit crystallisation event 8 - test against the member’s lifetime allowance.
In some cases, a 25% overseas transfer charge applies as well as a lifetime allowance charge, or instead of the charge.
Coming the other way – the overseas scheme only has to meet HMRC’s relatively basic definition of a pension scheme. But the other country could have its own rules and barriers.
Thank you – that concludes this vodcast on pension contributions for members who become non-UK resident.
If you’d like any further information, please contact your dedicated Scottish Widows representative.
Or you can also visit our Scottish Widows Adviser Extranet for a full range of technical resources, including Techtalk, MasterClasses and a wide range of CPD. Thank you once again.
Thanks very much and please look out for the next in our vodcast series.
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