Whose pension is it anyhow?

25 January 2017

Mike Down

We are now in an era of unprecedented pensions flexibility. The old days of being forced into buying an annuity have long gone. Although there is not (contrary to some people’s perception) a complete free for all, once you get to 55 you have a wide range of choices as what to do with the fund. One of those choices is to do nothing – that is to say not take any sort of pension even though you have the right to do so.

Your right to take a pension is clearly some form of asset, so by not exercising that right you are in effect depriving yourself of cash in your own hands. There is a nasty inheritance trap lurking here. Failure to exercise a right can be treated as a gift for IHT purposes.

Here’s a simple example. If I give George a plot of land worth £1m that is clearly a gift. So if I die within seven years that creates an IHT liability.

So what about this? I transfer the land to George but with the proviso that I have the right to buy it back at any time in the next 12 months for a nominal one pound. I’ve not really lost out here because I can exercise the option and get the land back: my wealth has actually been reduced.

But what happens if I don’t exercise the option? When it lapses George now has land worth £1m and I have nothing. By failing to exercise my right I have effectively transferred value to George. The IHT rules see through this ruse by saying that when I failed to exercise my right that was equivalent to a gift for IHT purposes.

So what has this to do with pensions? Well If I haven’t exercised my right to draw a pension then on my death there is less in my estate than there otherwise would have been and, depending on the rules of the scheme, the fund can then pass to other members of my family. Isn’t that rather like me having made a gift to them, in the same way as I made a gift to George when I didn’t exercise the option? You can I hope see the parallel.

Fortunately this problem was addressed in 2011 when failure to take pension rights was removed from this particular IHT charge. But before that an IHT charge was possible. There was a rather sad case in 2010 where a lady was diagnosed with terminal cancer just before the date on which she could have taken her pension. She lived long enough to reach that date but didn’t draw the pension because she had no need of the funds and so died with her pension undrawn. HMRC argued, successfully before the tax tribunal, that her omission to take her pension was deliberate and therefore created an IHT liability.

So why am I am mentioning this now? Because another case has just come before the courts on the pre 2011 legislation on the same point: did the failure to take a pension create an IHT charge? Fortunately this time the judges found a way of interpreting the legislation which meant that the IHT charge did not stick.

I don’t think that it would occur to most people that not taking up rights could create problems. This decision and the change in the law may have sorted out at least some of the tax problems, but there are other areas which this can be a problem – wills and personal insolvency are a couple which springs to mind. Dealing with assets you have got can be difficult enough: dealing with those which you don’t actually have can be far more of a problem.