Landmark ruling could see pension savers in ill health stung by a stealthy 40% inheritance tax charge

19 October 2018

The bereaved families of pension savers could be hit with an unexpected IHT bill, following a controversial landmark ruling.

The Court of Appeal found in favour of HMRC, despite two courts below previously finding against in the now-landmark Staveley case. 

As a result, anyone who is in ill health who transfers their pension and dies within two years could see the remainder of their pot taxed at 40%.

It does not matter whether the individual transferred out of a defined benefit (DB) pension into a defined contribution (DC) pension scheme or from one DC pot to another.

According to the 1984 Inheritance Tax Act most transfers should be exempt unless the transfer is seen to have offered a ‘gratuitous benefit’ to the member.

But in the Staveley case, HMRC challenged Mrs Staveley’s decision to transfer her pension and leave it to her children in November 2006. Mrs Staveley had been diagnosed with a terminal illness and, after a hostile divorce, wanted to ensure that her savings went to her children rather than her ex-husband. The only way to do this was to transfer her pension into a new scheme that would enable to update her beneficiaries.

HMRC argued that because Mrs Staveley transferred her pension knowing she was terminally ill, it was a "chargeable lifetime transfer" followed by an "omission to act". It argued these two acts were designed to deliberately reduce the value of her estate for IHT purposes. 

The Court of Appeal found in favour of HMRC, despite two prior hearings in the First-Tier Tribunal and the Upper-Tier Tribunal, finding in Mrs Staveley's favour. 

Commenting on the decision, Tom Selby, senior analyst at AJ Bell says: “This ruling at best causes major confusion for pension savers in ill-health and at worst risks landing their beneficiaries with a shock 40% tax bill on the money left behind by a loved one.”

“It is frankly bizarre that someone who transfers from one DC plan to another now risks being hit with a 40% IHT bill – even if the transfer doesn’t materially change the money that will be passed on if they die within two years."

He adds: “All this does is add extra pain and confusion for people when they least need it. This is why we are calling for a blanket removal of pensions from IHT altogether. It needs radical simplification to ensure these circumstances don’t keep coming up.” 

Ian Browne, pensions expert at Quilter takes a similar view. "Law is on the side of HMRC, however, that doesn’t make the current rules around pension death benefits any less cruel. They essentially penalize people who have a terminal illness for good financial planning."

He adds: "This is a legacy of an outdated inheritance tax system, which remains off kilter with pension freedoms.

"Under the current rules, if a pension transfer is made while someone is in ill-health then there is a risk that HMRC will challenge the IHT-free status of the death benefits if the person passes away within two years of the transfer. In the upcoming Budget and Inheritance Tax Review the Chancellor has the power to set this glaring discrepancy straight."

Moneywise has contacted HMRC for a comment. An HMRC spokesperson says: “The Court of Appeal unanimously upheld HMRC’s Appeals against the decisions of the First Tier and Upper Tribunals.

"HMRC believes that an individual transferring funds between pension schemes whilst in ill health, with a view to leaving the death benefits for others, will make a transfer of value which may give rise to inheritance tax.”

Pensions and inheritance tax

Unlike your property, savings and other investments, your pension does not form part of your estate on your death, and that means it won’t be covered by your will.

Exactly who gets your pension savings when you die is, perhaps rather surprisingly, down to the discretion of your pension provider. It will make its decision based on any information it has or manages to acquire once you have died.

Moneywise recommends writing a will for your pension. Read our guide to find out more.


In reply to by anonymous_stub (not verified)

Inheritance tax has done its work. It is time for reform. The intention was to break up the big estates, now it applies to the estates of almost everyone in the south east with a house and moderate savings. It either needs uprating after over 15 years at the present level or, better yet, abolishing.

In reply to by anonymous_stub (not verified)

What a surprise - something that will penalise the poor/low income more than the rich considering we have to use a deliberately underfunded NHS (which the tories are giving their donors/fund managers/US - once we leave the EU a free for all on NHS contracts) and the rich can afford better/premium healthcare! Another stealth tax on the poor!

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