HMRC Inheritance Tax: Customer Guide to Inheritance Tax

Contents

Tell me about alternatively secured pensions and Inheritance Tax

The Inheritance Tax rules on pension schemes have been updated to reflect the wider choices available to members of registered pension schemes on and after 6 April 2006 (A-Day). This guidance covers the Inheritance Tax treatment where scheme members aged 75 or over die with funds in alternatively secured pensions.

Briefly, Inheritance Tax is not chargeable on any left-over funds paid to a relevant dependant as pension benefits or where the funds are paid to a charity.

Apart from these exceptions, Inheritance Tax is chargeable in all other cases on the left-over funds (for example, where they are paid as a transfer lump sum death benefit to provide benefits for other scheme members) and on any remaining funds once the relevant dependant’s pension benefits cease.

Pension scheme administrators are responsible for accounting for and paying any Inheritance Tax due on these left-over funds.

What is an alternatively secured pension?

An alternatively secured pension is one which provides for payment of income withdrawals direct from a money purchase arrangement (link to money purchase arrangement in the glossary) to a member aged 75 or over and which meets the pension tax rules for registered pension schemes. There are restrictions over the amount of income that may be drawn each year which means that there will almost always be funds left-over on the scheme member’s death.

Are there any exemptions from Inheritance Tax on alternatively secured pensions?

Yes. There is no Inheritance Tax charged on any left-over funds in an alternatively secured pension paid to a relevant dependant as pension benefits or where the funds are paid to charity.

When is Inheritance Tax charged on alternatively secured pension funds?

The timing of the Inheritance Tax charge on the death of a scheme member with left-over funds in an alternatively secured pension is dependent on how the funds are applied under the pension scheme rules. The Inheritance Tax charge applies on the death of the scheme member unless the funds are applied to provide pension benefits for a relevant dependant in which case it is effectively deferred until cessation of the relevant dependant’s pension benefits and then it is only the residue of the left-over funds which is chargeable.

Immediate charge

Where the Inheritance Tax charge on the left-over funds applies on the death of the scheme member they will be added to the scheme member’s estate and tax will be calculated on the total amount.

The tax will then be apportioned between the estate and the pension fund, each benefiting from a share of the tax-free threshold. The personal representatives will be liable for the tax on the estate and the pension scheme administrators will be liable for the tax on the pension fund.

Example 1

Lloyd died aged 79 without any dependants. He had an alternatively secured pension fund (ASP) which was paid under the rules of the pension scheme as a transfer lump sum death benefit and so gave rise to an immediate tax charge. Lloyd’s estate was valued at £245,000 and the value of his alternatively secured pension fund was £135,000.

The Inheritance Tax on Lloyd’s estate was calculated as:

Lloyd’s estate £245,000
Value of ASP £135,000
Aggregate chargeable transfer
£380,000
less Inheritance Tax threshold
at the date of Lloyd’s death £285,000
£95,000
£95,000 x 40% = £38,000 Inheritance Tax

To apportion the tax between that payable by the personal representatives and that payable by the pension scheme administrators:

Value of estate / aggregate chargeable transfer x tax due = tax payable by personal representatives

245,000 / 380,000 x 38,000 = £24,500

Value of pension fund / aggregate chargeable transfer x tax due – tax payable by pension scheme administrators

135,000 / 380,000 x 38,000 = £13,500

Deferred charge

When the pension benefits payable to the relevant dependant from the left-over funds cease either on the death of the relevant dependant (or because they no longer qualify as a relevant dependant) Inheritance Tax will be charged at that time on the value of the remaining left-over funds (unless they are paid to charity on death of the relevant dependant).

The tax will be calculated by adding the value of the left-over funds at the date of the relevant dependant’s death (or the date on which the payments to the relevant dependant cease) to the value of the estate of the original scheme member. The Inheritance Tax threshold and rates will be those applying at the date of the relevant dependant’s death (or the date the payments cease).

Example 2

Rajiv died aged 77. He had an alternatively secured pension fund which passed to his relevant dependant; his wife Parmjit. Rajiv’s estate was valued at £300,000.

Parmjit died aged 69 when the IHT threshold was £312,000. The value of the left-over alternatively secured pension fund on Parmjit’s death was £400,000.

The Inheritance Tax due in respect of this chargeable event is calculated as:

Value of Rajiv’s estate £300,000
less IHT threshold at the date of Parmjit’s death £312,000
balance of threshold remaining 12,000

Value of left-over funds at Parmjit’s death £400,000
less balance of threshold available 12,000
taxable £388,000
Inheritance Tax is £388,000 x 40% = £155,200

The Inheritance Tax is payable by the pension scheme administrators.

Who is liable for the tax on an alternatively secured pension fund?

The pension scheme administrators are liable for the tax on the left-over funds in an alternatively secured pension fund.

When does the Inheritance Tax charge on alternatively secured funds apply to a dependant’s estate?

This applies where a dependant inherited lump sum death benefits from a scheme member who died under the age of 75 and under the pension scheme rules subsequently chose to take those benefits as an alternatively secured pension. In this instance on the death of the dependant the left-over alternatively secured pension funds will be treated as part of the dependant’s Inheritance Tax chargeable estate.

The value of the remaining left-over funds will be added to the dependant’s estate and Inheritance Tax will be calculated on the total amount. The tax will then be apportioned between the estate and the pension fund. The personal representatives will be liable for the tax on the estate and the pension scheme administrators will be liable for the tax on the pension fund.

Example 3

Alice died aged 69 and her lump sum death benefit was payable under the pension scheme rules to her invalided brother, Peter who was her dependant. Peter was aged over 75 at the date of Alice’s death and chose to take the benefits as an alternatively secured pension.

When Peter died aged 77 his estate was valued at £300,000 and the value of the alternatively secured pension fund was £90,000.

The Inheritance Tax on Peter’s estate is calculated as:

Peter’s estate £300,000
Value of ASP £90,000
Aggregate chargeable transfer
£390,000
less Inheritance Tax threshold
at the date of Peter’s death £285,000
Total
£105,000
Inheritance Tax is £105,000 x 40% = £42,000

To apportion the tax between that payable by the personal representatives and that payable by the pension scheme administrators:

Value of estate / aggregate chargeable transfer x tax due = tax payable by personal representatives

300,000 / 390,000 x 42,000 = £32,307.69

Value of pension fund / aggregate chargeable transfer x tax due - tax payable by pension scheme administrators

90,000 / 390,000 x 42,000 = £9,692.31

Which forms do I use?

If you are a pension scheme administrator and want to report a chargeable event on an alternatively secured pension you should use the form IHT100 and the event form IHT100g. The IHT110 notes will help you to complete the forms. If you want to tell us about an event which is exempt because all of the fund is passing to a relevant dependant or to charity you should use form IHT105. The notes to help you fill in the IHT105 are on the back of the form. All of these forms are available from our Probate and IHT Helpline.

If you are the legal personal representative of the estate of a person who had an alternatively secured pension, you should complete the form IHT400, and the supplementary page D6. Both of these forms are available from our Probate and IHT Helpline.