Inheritance Tax  

HMRC denies IHT pension transfer loophole exists

HMRC denies IHT pension transfer loophole exists

Advisers may be inadvertently racking up hefty inheritance tax bills for their clients, thanks to a loophole that means pensions can in some cases be treated as part of the client's estate. 

According to Jonothan McColgan, a financial planner and director of Combined Financial Strategies, almost any transfer between two pension vehicles could be treated as a "chargeable lifetime transfer" if the client dies two years after the transfer was made.

However, he said there is currently no certainty this was the case, because the legislation itself is not clear, and there is no case law to set a precedent for future interpretation. 

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He warned HM Revenue & Customs could decide to take advantage of the loophole in order to raise revenue. 

Last week, Financial Adviser reported that transfers out of defined benefit schemes could be treated as a chargeable lifetime transfer if the member knows he or she is in poor health when the transfer is made, and then dies within two years of the transaction.

If the transfer value is more than £325,000 - the current nil rate band - every pound above that figure would attract a 40 per cent tax.

But Mr McColgan said this danger applied to transfers out of all pensions, including defined contribution schemes, self-invested personal pensions, drawdown products, personal pension schemes and flexi-access accounts.

He said lack of clarity from HMRC meant there was no certainty over whether or not such transfers would attract the tax.

He said: "The main problem is that there has not been any specific public case law on this and HMRC have not shared how this works in practice," Mr McColgan said. 

He said making contributions to a pension scheme within the last two years before death "could also fall foul" of the rules.

He added a large number of advisers were probably unaware of this potentially costly ambiguity.

Les Cameron, head of technical at Prudential, confirmed all pension to pension transfers were liable to this tax treatment.

This, he said, was because when a pension transfer is made, it could go into a pension that automatically goes into the member's estate on their death.

Therefore, if the client chooses not to pay it into such a pension, HMRC can treat it as a loss to the estate, and therefore a chargeable lifetime transfer.

But he said the real confusion came over how HMRC values the taxable sum. Traditionally, he said it would have been the difference between the retirement benefit - calculated at 25 per cent tax free cash, plus a 10 year annuity - and the death benefit.

But he said pension freedoms had made that less certain, since annuities were no longer the dominant retirement product.

He agreed with Mr McColgan that there was neither case law nor guidance from HMRC as to how the taxable sum was calculated.

He recommended advisers assume the worst and expect it will be the full transfer value - while at the same time saying this was unlikely.