Writing for Taxation magazine’s Readers’ Forum, BKL private client tax specialist Terry Jordan answers a query involving a widow making gifts from a pension scheme drawdown in order to mitigate inheritance tax (IHT).
The tax query
‘My client’s husband, 74, died in 2019. He was the sole beneficiary of a small self-administered pension scheme valued at £750,000 comprising cash at bank. My client, 68, has post-tax income in excess of her usual standard of living, confirmed by studiously completing page 8 of form IHT403 for several years.
As pension schemes will fall within the charge to IHT from 6 April 2027, my client (with a very substantial estate) proposes to draw down a pension of £200,000 now. This would be tax-free as she flexibly-accessed her dependants’ drawdown rights within two years of the date of death. She will then gift £100,000 to each of her two adult daughters. She then plans to draw annual pension income from which she will make further gifts of £100,000 to only one daughter in each of the following five years. The drawdowns will provide sufficient additional income to cover the £100,000 gift to each daughter now, and then £100,000 to one daughter only from year two and onwards.
Considering IHTA 1984, s 21, IHTM14242 and IHTM14243, our client having sufficient income to maintain her standard of living without the annual pension drawdowns, and our client documenting her intention of future gifts at the outset, do readers agree the ‘one-off’ gift to daughter A will be considered as part of regular gifts out of income if my client plans to gift all her excess income to only daughter B in future years? Secondly, as the pension income is tax-free in my client’s hands do readers agree this is a neat way of her receiving regular tax-free pension income then gifting it all away, on a regular basis, it also being exempt from IHT?’ Query 20,549 – Gifted.
Terry Jordan’s reply: What Gifted suggests is a neat way of mitigating IHT.
‘Gifted’s client has been making regular gits out of surplus income for several years to take advantage of the exemption from inheritance tax in IHTA 1984, s 21. Because her late husband died before age 75, she can access his pension free of income tax. It is proposed that she should draw £200,000 now and gift £100,000 to each of her two daughters. In future years she will withdraw and gift £100,000 to only one daughter.
A key question is whether such withdrawals will constitute ‘income’ for the purposes of the exemption. My understanding is that if I take 25% from my SIPP it will be tax-free capital and that future withdrawals will constitute income subject to income tax. On the premise that the client’s withdrawals will have the nature of income, Gifted asks if the one-off gift to daughter A will be immediately exempt given the commitment to make future gifts.
The Bennett case (Bennett and others v CIR [1995] STC 54) is authority for the proposition that the exemption can apply to early gifts in an intended series. In that case Lightman J said: ‘The amount of the expenditure need not be fixed in amount nor need the individual recipient be the same … As regards the payees, it is sufficient that their general character or the qualification for benefit is established, eg members of the family or needy friends.’
Accordingly, I agree with Gifted that this is a neat way of mitigating inheritance tax although it does require the client to live long enough to exhaust the husband’s pension (or to die before 6 April 2027). If she is in normal health the client might consider withdrawing the entire pension in one go, gifting it as potentially exempt transfers (PETs) to the daughters and insuring against premature death.
Last year The Telegraph published an article suggesting that a UK resident with a substantial pension pot could become resident in Dubai and then make UK income tax-free withdrawals from the pot to facilitate regular gifts to avoid the imposition of inheritance tax from 6 April 2027 even though they would remain a long-term UK resident for IHT purposes.’
The full article was published in Taxation magazine (issue 4993) and is available to subscribers here on the Taxation website.
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