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The ages of wealth

B 74

y my reckoning the UK tax treatment of pension benefits has changed six times in the past seven years. I often hear the tax position of pension lump sum death benefits (LSDB) on death described as being ‘free of inheritance tax’ (IHT). This is a dangerous oversimplification, and while many

pensions, including company life assurance plans written under pension rules, enjoy privileged status, there is a variety of plans, and a different client situation could lead to a different outcome and thus require different recommendations. Pension jargon is rife; frequently life insurers, pension providers and financial advisors will all use different words to describe the same thing. For example, in determining the treatment of death benefits, it is important to distinguish whether an LSDB has paid any retirement benefits. In this situation, pension benefits might be referred to as unvested, uncrystallised, pre-pension or pre-retirement. Despite the difference in nomenclature, the status is the same: neither pension commencement lump sum (PCLS – ‘tax-free cash’, as it was known) nor income has been taken. In assessing the tax treatment of LSDBs there are

several variables to consider. In this article I look at inheritance and income taxes, but note that there is always the potential for lifetime allowance (LTA) charges. Broadly speaking, an individual can accrue only GBP1.5 million of pension benefits before tax potentially falls due. Various protections were available for those with greater levels of benefits (in 2006 and 2012), and it is proposed to reduce the LTA further to GBP1.25 million in2014.Anylumpsums paid on death in excess of this will usually be taxed at 55 per cent. Due to the broad range of planning and protections available, this is a complex area. Encouraging clients to seek professional advice if they are in excess of, or approaching, these limits is important. Lump sum and money purchase (or cash balance) benefits are assessed based on the value paid out, whereas scheme pension arrangements (principally ‘defined benefit’ dependant’s pensions) are not tested against the lifetime allowance on

APRIL 2013


death; but in life they are assessed against the LTA with a 20x multiple, with any lump sums added on top. Unless otherwise stated, the examples below are for money purchase death benefits.

Before age 75, and before taking benefits An uncrystallised LSDB should normally be paid to beneficiaries within two years of the reported death. The nature of the scheme will define the rules that govern these payments, but most trust-based schemes will have discretion as to whom benefits can be paid. However, the nature of the scheme should be verified, as not all schemes have discretion. ‘Retirement annuities’ and ‘section 32’ policies (commonly known as buyout bonds) are contract- based rather than trust-based. Although they are rare, I have also come across pensions that have been established through board resolution or deed poll – accordingly no master trust exists, and while one would hope the administrator has trustee-like discretion to choose to whom benefits are paid, this may not always be the case.

Use of trusts for IHT mitigation For trust-based pensions (most occupational and personal pensions, including self-invested personal pensions (SIPPs) and stakeholder plans) a pilot trust can be the nominated beneficiary of any LSDB. It is held that the pilot trust is a related settlement (s81 of the Inheritance Tax Act 1984) to the original pension fund, so an advisor must look back to any ceding pension schemes for both the ten-year periodic charges and the number of nil rate bands applying. Although I’ve seen contention over the matter, it seems that HMRC’s interpretation of s81 is that splitting one LSDB across several pilot trusts is not effective for reducing period charges, but a GBP1 million pension pot ceded from five smaller trust-based schemes (as opposed to contract-based, as above) could have up to five nil-rate bands. For deed poll or board-resolution-based schemes (the minority of personal plans), an assignment to trust or nomination to a pilot trust should work. Verification of the preference of the scheme administrator is advisable. Insurance contracts


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