Pension transfer tax hit awaits those in poor health

People in poor health who switch pension providers to take advantage of the new flexibilities could unknowingly be making their savings vulnerable to an inheritance tax (IHT) hit.

Since the new pension freedoms came into effect in April 2015, not all pension providers have been offering all the possible options under the new rules - which in theory allow over-55s to access their pension pots as and when they like.

People have been encouraged to shop around and consider moving their money to a new provider if necessary to get the flexibility they want.

One of the appealing new pension policies says IHT no longer applies to money passed on from a registered pension scheme in the form of a lump sum or income.

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Following the changes that came into effect in April, assets can pass on within the pension wrapper and be subject only to the beneficiary's marginal rate of tax; if the saver dies before age 75, withdrawals are completely tax-free.

However, if someone in poor health transfers their pension to a new provider and dies within two years of making the switch, HMRC will make their pot subject to IHT.

This is because HMRC would say they 'made a fresh disposition of their death benefits' - meaning a transfer of value made specifically for IHT purposes.

The tax office would investigate if the member was in poor health when they made the transfer, only to die less than two years later.

If HMRC found that the member's life expectancy was shorter as a result of their health condition - and if the member knew this - some or all of the transfer could be included in the member's estate.

This trap applies to people moving their final salary schemes to access cash or take advantage of the new flexibilities, as well as those moving accumulated defined contribution schemes from one provider to another.

As a consequence, some pension savers could find themselves trapped in schemes that don't offer the flexibilities they need, because they are worried that if they transfer to a more suitable scheme and then die within the next two years, their pension might be hit by an inheritance tax bill.

'There may be many reasons why individuals wish to transfer pension funds when they know their life expectancy is impaired,' says Jon Greer, resident pensions expert at Old Mutual Wealth; 'for example, if their existing scheme does not offer the full range of flexibilities that give individuals greater freedom to pass on their pension funds.

'We believe this tax treatment creates an unnecessary restriction for those with impaired life expectancy and risks punishing their families by subjecting pension assets to unnecessary IHT.

'This is not in the spirit of the pension freedom reforms.'

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