Writing for Taxation magazine’s Readers’ Forum, BKL private client tax specialist Terry Jordan answers a query on the inheritance tax (IHT) implications of a husband’s pension withdrawal and gift to his wife, followed by a gift from his wife to their adult daughter.
The tax query
‘My clients are a retired couple. The husband is 70 years old and in poor health. The wife is 73 and in good health.
The husband has a large pension fund and is looking at ways to mitigate his inheritance tax (IHT) liability. He wishes to withdraw monies from his pension fund, either by way of a partial tax-free portion encashment or a portion of income, or combination of the two, and then gift this to his wife.
In view of the anticipated life expectancy for the wife here being considerably longer than that for the husband, it is then the wife’s intention to make a lump sum gift to their adult daughter. The wife is more likely than her husband to live for seven years and the couple hope that the gift to the adult daughter will drop out of the wife’s estate for IHT after the seven-year anniversary of the gift.
Do readers anticipate any difficulty with this strategy?’ Query 20,625– Partridge.
Terry Jordan’s reply: Best strategy may be to wait and see
‘Until last year’s Budget, advice (from suitably qualified financial advisers) to clients generally was to spend other savings, including those in ISAs, before accessing a pension fund because it would pass on death to nominated beneficiaries free of inheritance tax.
Under current proposals, the IHT treatment will change from 6 April 2027, when unspent pension funds will be aggregated with free estate assets and any other property liable to IHT on death and the nil rate band will be apportioned rateably. The normally unlimited spouse exemption will still potentially apply. If the owner of the fund dies before age 75, the recipient(s) will be able to access the value without an income tax charge; if on or after age 75, income tax will be due on withdrawals.
Here, Partridge’s client is considering taking value from his pension and gifting the money to his wife, who would then make gifts to their adult daughter as potentially exempt transfers (PETs), which would be free of IHT after seven years. If that sequence is preordained, HMRC could assert that under the associated operations provisions of IHTA 1984, s 268, the donor should be regarded as the husband. See HMRC’s Inheritance Tax Manual at IHTM14833:
‘Where property given unconditionally by one spouse or civil partner (IHTM11032) [ tinyurl.com/bdh7srht ] to the other is subsequently transferred by the latter to a third party, you cannot use the associated operations provisions to attribute the transfer to the first spouse or civil partner.
The chief secretary to the Treasury assured parliament that this would be HMRC’s practice, and it was publicised in a press release dated 8 April 1975.
However, where the transfer between spouses or civil partners is part of a more complex series of transactions which taken together are the way one of them makes a disposition to a third party, it may be more appropriate to use the associated operations to allocate the transfer(s) to the correct transferor.’
We are told that the husband is in poor health, but not his prognosis. As there would be no income tax on withdrawals from the pension fund in the next four and a bit years, and the IHT spouse exemption would apply provided the wife survived and took the fund, the best strategy may be to wait and see.’
The full article was published in Taxation magazine (issue 5012) and is available to subscribers here on the Taxation website.
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