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A DGT with 100% access and 100% discount?

The potential of a pension as an IHT wrapper - by Clare Moffat, Technical Manager at Prudential

100% access and 100% discount - what type of wrapper could this be? A pension! 

Post flexibility there is 100% access (for those over 55) and normally pensions are Inheritance tax (IHT) free.  With flexibility the options available on death mean that pensions should normally be first in, last out. 

However, the word ‘usually’ or ‘normally’ will often precede the words ‘IHT friendly wrapper’.  Why?  In what scenarios does IHT apply? How does it work for contributions? What happens with spousal bypass trusts (SBT)? Pensions are known to be an inheritance tax friendly wrapper but is that always the case? 

To fully understand the benefits of a wrapper then we also need to understand the limitations.

First in, last out

Pensions should be paid in when the highest amount of tax relief is available and extracted when the least amount of tax is payable or even left if pension income isn’t needed.

Given the beneficial IHT treatment of pensions a logical approach to IHT planning could be to finance all living expenses from non-pension assets at least until age 75 has been attained and possibly later if passing on death benefits is important to your clients. Non-pension assets are normally 'in the estate' so using them up would potentially lessen any future IHT bill.

Section 3 (3) of the Inheritance Tax 1984, which was designed to prevent the diminishing of an estate by deliberately failing to exercise an option, was a significant drawback for this strategy. However, this legislation was removed for pensions in Finance Act 2011. In case of any uncertainty in relation to drawdown, this year’s Budget confirmed that there is no charge to IHT if funds are designated to drawdown and not withdrawn and this change was backdated to 6 April 2011.

If your client dies post 75 then any recipients who are individuals would pay their marginal rate of income tax on withdrawal. This still could be managed in such a way through drawdown to make sure that withdrawals take place in a tax-efficient manner.

Passing pensions through the generations keeps it within that IHT tax-efficient wrapper. This is especially useful if the original member expresses a wish that their spouse is the beneficiary.  That spouse may not need any income but they may have an IHT problem.  They can leave it within their dependant’s drawdown without taking any income and then pass on the fund to other beneficiaries without any IHT and so on.

However, sometimes the original member prefers more control over the beneficiaries and that is where a SBT can be useful. Control is one of the major reasons for setting up a SBT. The 6 April 2016 changes in relation to individuals and non-individuals mean that if a trust receives a lump sum from a pension scheme and  the member was over 75 then 45% will be deducted by the provider. However, if that money is then passed onto an individual then there is a reclaimable tax credit.

So, paying into a SBT works out the same as paying to another beneficiary? Well, not quite.  There are potentially exit and periodic charges. For more information on actually what this would look like, please see Mark Devlin’s article in July’s Oracle Technicalas he looks at an actual case study and works through the numbers.

Where else might there be IHT pitfalls?  Well, there are two main areas where IHT might apply; paying into a pension and death benefits. 

  1. Contributions to a pension

 Normally contributions to a pension are not considered to be lifetime transfers of value and IHT is not an issue as the underlying principle that the member is making contributions to enjoy in retirement applies.  However, there are two circumstances where this is not the case.

 a)      Contributions to a pension scheme where the member is in ill health may be a transfer of value if the member does not survive for 2 years. If your client has been making regular monthly contributions for some time then it is unlikely that this would be considered to be a transfer of value, even if they knew that they had a terminal illness.

However, making a one-off contribution of £40,000 while in ill health would be considered to be a transfer of value as it is depriving your client’s estate (and therefore the tax man) of a large amount of money at a time when your client knows that they are not going to survive to take their retirement benefits.

If you have a client in ill health then large pension contributions need to be thought about and the potential IHT implications discussed. Any contributions paid in the 2 years before death must be recorded on the IHT 409 form after death.

b)      Contributions for others are a transfer of value. However, often one of the exemptions can apply, such as the annual exemption or normal expenditure out of income exemption. If they did not apply, then they may be potentially exempt.

  1. Death Benefits

Forms part of the estate

As mentioned above, death benefits do not usually form part of the estate. However, in certain scenarios they will.

Where the payment forms part of the estate then IHT may be payable. Examples of where this might be are:

i)                    The estate has a legal entitlement – for example if a retirement annuity contract has not been assigned into trust then the estate has a legal entitlement;

ii)                  If there are outstanding guaranteed payments from an annuity; and

iii)                If there are arrears of annuity payable to the member on death.

In i) and ii) there is little that can be done to mitigate any IHT. However, any clients with IHT issues and retirement annuity contracts that haven’t been assigned into trust (and they want to keep their retirement annuity contract) should do this as soon as possible.

Lifetime transfers

Lifetime transfers can also attract IHT in certain circumstances specifically assignment and transfers. Similarly to paying contributions, if an assignment happens and if the member will survive to take their benefits then the value of any transfer of value will be nominal.  However, if the member dies within 2 years then there could be a substantial transfer of value. This will also apply when a transfer takes place from a scheme with no discretion/payable to the estate to a scheme with discretion.

Transfers from one scheme to another are considered to be transfers of value.  As above, the 2 year rule will normally apply. Working out the actual value may be difficult.  When transferring from one scheme which gives return of fund for death benefits to another scheme that operates in the same way then the transfer value will probably be nominal.  However, transferring from a Defined Benefit (DB) scheme which pays a set amount of death benefit to a scheme where the death benefit is return of fund could mean a large transfer of value.

In most scenarios, completing a transfer such as this will not be a good idea if your client is in poor health.  However, tax is only bad if the net benefit is worse.  If your client has no spouse and adult children, is very ill and is in a DB scheme with a large transfer value, then it still could make sense.  The adult children would probably rather have 60% of something rather than 100% of nothing.  As with most financial planning, it is about working out the numbers and what the client and the client’s family value the most while explaining the tax consequences.

General power to dispose

The third type of death benefit scenario is that of a claim on the general power to dispose of death benefits. This applies where the member had an unfettered right to bind the trustees or administrators or had a power of nomination to pay the death benefits to a specific person or to their estate. Instead of the scheme administrators investigating and deciding who to pay, there is no such discretion and the scheme administrator is obliged to pay to that person or the estate which removes the right to a payment free of IHT.

Sometimes this is explained as being a ‘hard nomination’.  This type of nomination should not be confused with a power of nomination as they are normally non-binding expressions of wish.

There are certain well-known schemes which have this such as the NHS. It is important to know if this is the case as there could be a large IHT bill for your client’s family to pay when they thought that IHT planning had taken place.

The power of disposal would still apply even where the benefits were ordinarily held under discretionary trusts if the member could direct at any time where the death benefit was to be paid.

Whether or not this would apply would be entirely down to an individual scheme's documentation. As is mentioned often when death benefits are discussed, scheme rules rule. It may be possible to make a binding nomination where it is irrevocable and happens in good health/over 2 years prior to death or where the trustees are bound to pay to a restricted class of dependants but this is worth checking.

A great wrapper - but fail to plan and you plan to fail

Pensions are a great wrapper for IHT planning in general but it is essential to know what type of plans your clients have in case they might not be as effective as you first thought.

Considering death benefits at annual review is already vital, it’s not just a case of updating nomination forms. You need to check if the client’s scheme allows their wishes to be met. When this takes place, then checking if there is a power of disposal is important too or other issues which could mean that IHT is due.

Check that there are no section 32s without a trust wrapped round them. Knowing the tax implications of a transfer or making contributions in ill health will also be crucial. It may still be worth making the transfer but know the consequences.

Make sure that ‘normally’ IHT free does actually apply to your clients.


Prudential can offer a host of support to help you with estate planning, including:


  • Estate planning hub– easy access to online tools and support material
  • ClientFinder – shows you the concentration of different client types in your area – including those who could be looking for estate planning advice right now!
  • Planning Matters– read Margaret’s case study
About the author
Clare Moffat

Clare Moffat is a member of Prudential's Technical team, based in Craigforth, Stirling.

Clare specialises in pensions. She has a law degree and a diploma in legal practice. She qualified as a lawyer and Notary Public in September 2002 and then spent 5 years at Aegon Scottish Equitable in the legal department before moving to Pinsent Masons LLP in November 2007. While at Pinsents Clare worked for many insurance companies developing pension products, reviewing material and presenting at seminars as well as offering technical support. Clare joined the team in October 2011 and is a member of the Law Society of Scotland.