How to navigate inheritance tax and pensions with clients

More and more people are paying IHT and the nil rate band has remained at £325,000 since 2009. Although the introduction of the residence nil rate band has improved the situation for many, planning is more important than it has ever been. 

While pensions are not normally subject to IHT there are circumstances where they are and, while you may be aware of these issues, it is highly likely that your professional connections - estate planning solicitors, for instance - may not be.  

How can you help them through the complexities of IHT and pensions?

When is IHT payable on pensions?

There are situations where there is a contractual entitlement for the estate to benefit and this would mean that IHT could be payable.

Pension freedoms made pensions more attractive than they were before, as pensions can now be cascaded through the generations. If the pension is in a discretionary defined contribution scheme then it is not normally subject to IHT. It makes sound financial sense to use any estate subject to IHT before using pensions.

This should allow pensions to grow and the amount of IHT payable by beneficiaries to reduce.

But there are circumstances when IHT does apply to pensions. Let us take a look at the three most common scenarios.

Contributions

Contributions are not usually lifetime transfers but they may be subject to IHT if:

•    The member knows they are ill and unlikely to survive to take their retirement benefits and those retirement benefits will be outside of the estate.

In this situation contributions within the past two years will be considered to be a transfer of value. If these contributions are unusual in size and not part of a regular arrangement then this will need to be noted on the IHT409 form.

This could be where the client has been regularly paying £100 a month and then in the past two years has increased the contribution to £1,000 a month.

They are knowingly trying to move IHT-able estate to an IHT-friendly environment. However, if contributions remained at £100 per month then this would be classed as a regular arrangement. 

•    The contributions are to someone else’s pension. The client is then transferring money from their estate to the estate of someone else for that person’s benefit and so this is a lifetime gift. IHT will not apply if there is a valid exemption, such as the spouse’s exemption or the annual exemption of £3,000.