UK Pensions: beware inheritance tax on pension transfers made shortly before death

In a recent UK case (HMRC v Parry) the Court of Appeal found that inheritance tax was due on pension benefits which were transferred out of a defined benefits (or final salary) to a defined contribution (or money purchase) scheme shortly before a terminally ill member died.

Following a divorce, Mrs Stavely transferred her rights from a pension she had set up with her ex-husband into a new scheme, and then named her children as beneficiaries, to avoid the benefits being paid under a binding nomination rule to her ex-spouse. Following the member’s death a few weeks later, HMRC applied inheritance tax to the transfer on the basis that it conferred a gratuitous benefit on the children.

The both the First and Upper Tax Tribunals found against HMRC, but the Court of Appeal allowed HMRC’s appeal. The latest decision is now to be appealed in the Supreme Court.

Comment

This case highlights the risk for members of making defined benefit to defined contribution transfers where the transferring scheme has a binding nomination rule for death benefits (here this was a section 32 policy but the principle could apply to other arrangements), but the receiving scheme makes distributions under discretionary trusts.

Members (particularly those in serious ill-health, like the member in this case) should beware of potential inheritance tax implications where they transfer their benefits, or delay taking a pension, and do not survive for two more years afterwards. Where a member is terminally ill and is considering making a transfer, tax advice should be sought so that the beneficiaries do not eventually receive an unexpected demand for inheritance tax.

If the Supreme Court were to find for the late member’s beneficiaries, this would be welcomed by families where a scheme member seeks to transfer from a binding nomination scheme to one awarding death benefits under discretionary trusts. Such a ruling would negate the risk that HMRC may seek to levy an inheritance tax charge where such a transferring member, who is in ill-health at the time of the transfer, fails to survive for a further two years. Whilst discretionary trust provisions apply in the vast majority of workplace pension schemes, many historic contract based schemes will be subject to binding nomination rules, so care should be taken.