Mind the inheritance-tax trap when transferring your pension

Pension experts urge savers considering transferring their occupational pensions to different schemes to take professional advice. In some cases, taking advice is a legal requirement. If you’re in poor health, it is crucial: shifting your pension could leave your heirs facing an inheritance tax (IHT) bill if you die shortly thereafter.

A landmark legal case just concluded after a long battle between HM Revenue & Customs and a bereaved family underlines the risks. HMRC argued that a mother with a terminal illness had transferred out of one type of pension plan into another knowing she would not live long enough to claim retirement benefits.

Her aim, HMRC argued, was to prevent her sons from having to pay IHT on the money; when she subsequently died, HMRC told the sons they would therefore have to pay the tax.

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The Supreme Court steps in

The dispute took more than two years to resolve, with the Supreme Court finally ruling against HMRC last month.

However, pension advisers warn that the ruling was based on the individual circumstances of the case and that HMRC may continue to argue the principle in similar situations. The case has serious implications for savers in ill-health. When someone dies, it is only pension transfers that have taken place in the previous two years that have to be declared to HMRC as part of the assessment of whether any inheritance tax is due. Transfers undertaken previously automatically fall outside of the tax net.

But HMRC’s view is that a pension transfer made with the deliberate intention of reducing a potential inheritance-tax bill should not be allowed to deliver this benefit. It has therefore sought to tax families it judges to be in this position. Last month’s legal ruling effectively places some limits on HMRC’s powers, but it does not take them away altogether. Every case is different. Broadly speaking, savers transferring out of some old-style pensions set up several decades ago are at most risk of being caught out, because money in these policies falls within the inheritance-tax net, unlike the savings in most other types of pension.

This was the type of policy considered in last month’s case. However, transfers out of defined-benefit schemes into defined-contribution plans may also be caught, because such switches sometimes increase the size of the estate it is possible to leave to your heirs. The bottom line: seek professional advice on any transfer, especially if you’re in poor health. Otherwise you may leave your family with a knotty tax problem.

Fixed fees will feed on your savings

Are you paying fixed fees on your workplace pension plans? If so, these could destroy the value of your savings – particularly where you have small pots of cash to which you are no longer contributing, such as plans with previous employers.

Most workplace pension schemes charge fees as a percentage of the value of your savings. Unfortunately, some levy a fixed cash amount instead. Where your pension savings are small, such charges will erode the value of your money over time. They could even wipe it out altogether, according to pensions specialist LCP.

The firm is urging the government to abolish fixed fees as part of its wider review of the pension charges that providers of workplace pensions are allowed to make. Such fees are particularly damaging for low-paid workers, LCP points out, potentially undermining their efforts to save for retirement. In the meantime, however, savers with small pension amounts should check how they are being charged. It may be possible to consolidate your savings by transferring old pensions to a scheme that offers more competitive charges.