Court of Appeal decision highlights inheritance tax risks of transfers between pension schemes when in ill health
A terminally ill woman, Mrs Staveley, transferred the funds held in a pension policy (granted to her as part of a settlement following an acrimonious divorce) into a new personal private pension (PPP) in order to avoid the possibility of the benefit of the policy reverting to her ex-husband.
The key difference between the original pension policy and the PPP was that, on her death, the original policy would have passed into Mrs Staveley’s estate, following which it would be taxable at a rate of 40 per cent, before being distributed to her sons as beneficiaries of the will. Under the PPP, Mrs Staveley nominated her sons as beneficiaries of the scheme who would then receive the sums directly and free of inheritance tax.
Mrs Staveley died six weeks after the transfer into the PPP. HMRC argued inheritance tax was due because the transfer, and the omission to take any pension benefits to which she was entitled, was a “disposition” constituting a “transfer of value” made with the intention of conferring a gratuitous benefit on her sons.
The court had to consider whether the following requirements were satisfied in order for an inheritance tax charge to apply:
- was there a disposition made by Mrs Staveley which reduced the value of her estate;
- did the “purchase exemption” apply; i.e. was the disposition not intended to confer any gratuitous benefit on any person; and
- did the omission to take pension benefits mean that the value of Mrs Staveley’s estate diminished and the value of her sons’ estates increased?
Court of Appeal ruling
The Court of Appeal decided the First Tier Tribunal was wrong to conclude that there was no intention by Mrs Staveley to confer a gratuitous benefit to her sons. The judges were divided on the precise reasons; the majority judgment found that for inheritance tax to be chargeable there must be an intention to improve the beneficiaries’ position. Although the court decided that there was no such intention in relation to the pension scheme transfer itself (as the sons were going to benefit either way and the inheritance tax saving was not part of Mrs Staveley’s motivation in this particular case), the fact that Mrs Staveley did intend an improvement in her sons’ inheritance by the omission to take benefits, and the fact that this omission was associated with the transfer, meant that the overall “transaction” gave rise to a charge to inheritance tax.
It is worth noting that whilst the Court of Appeal found that the transfer of assets from one pension scheme to another can be subject to inheritance tax as a transfer of value, the requisite value is only triggered when the transferor is suffering from a major health issue. This is because an actuarial assessment of the value of such a transfer will be far higher than that of a transfer where the person in question in good health (which may be only negligible).
Regarding the omission to take benefits, the Court of Appeal found that Mrs Staveley made a continuing decision not to take benefits, each and every day before her death, which meant the omission was an associated operation to the transfer. The sons’ estates were found to have been increased by the continuing omission and so HMRC succeeded on this point.
Whilst this case is clearly fact specific, its implications will be of interest to anyone looking to transfer their pension schemes (bearing in mind the recent increase in migrations of defined benefit to defined contribution pension schemes).
This judgment confirms the complicated rules on inheritance tax and the transfer of pensions where the transferor dies shortly after. It demonstrates that the intentions and health of the transferor are important when assessing the likely liability to tax. In short, HMRC is likely to view any transfer of a pension scheme by an individual who is in poor health and who dies within two years as a transfer of value.
In contrast a simple omission to take benefits during a person’s lifetime, even if they are in poor health, cannot give rise to a charge of inheritance tax if there is no associated transfer between pension schemes.
However, what the Court of Appeal decision shows is that a pension transfer at a time when the relevant individual is in poor health will not, of itself, give rise to an inheritance tax charge. There must also be some intention to confer a gratuitous benefit on some person. In relation to the majority of pension schemes, death benefits will be held in trust for nominated beneficiaries, and will not pass into the pension-holder’s estate on their death. A transfer to another scheme under which the death benefits are held for the same beneficiaries is not therefore a problem. It is only if there is an associated omission to take benefits during a person’s lifetime that there will be a charge to inheritance tax. Individuals should therefore take care to ensure that if they are not in good health, at the point they transfer a pension scheme, they can show that they do not intend to omit to take pension benefits to which they are entitled in order to benefit another person’s estate.
It is important to obtain professional advice before transferring either defined contribution or defined benefit pensions, so as not to fall foul of the complex legal framework. This case reiterates the importance of timely lifetime planning which takes into account all assets including pension schemes.