Inheritance Tax (IHT) is a charge that is applied to your estate on your death. It is charged at a flat rate of 40% on any assets over your inheritance tax nil rate band.
If you die whilst in pension drawdown and a lump sum is provided for a spouse, civil partner or financial dependant, there should not normally be a charge to inheritance tax, although a 55% tax charge (not inheritance tax) will be deducted where a lump sum is paid.
Contracted out pensions paid to your estate could potentially be subject to inheritance tax.
This is a brief summary of our current understanding of a complex area. However tax rules are subject to change and if your decision is based on tax considerations it is important to keep it under review and up to date. If you are unsure or concerned about inheritance tax you should seek advice.
What if I just take tax free cash?
There is a distinct difference in the way death benefits are treated, depending on whether you have “taken benefits” or not.
Tax free cash is only available if you take benefits, even if this is by moving into pension drawdown and not taking an income. The fund which moves into pension drawdown will be subject to the rules outlined previously. In particular if you die whilst in pension drawdown any lump sum payments will be subject to a 55% tax charge.
If you have not taken any benefits when you die (i.e. you have not taken any tax free cash or made funds available to take an income), there is normally no tax to pay when it is passed on to your heirs as a lump sum until the age of 75 years when the 55% tax charge applies.
IMPORTANT: You are now potentially subject to UK inheritance tax on the funds on death.
A recent court case of Fryer & Others vs. HMRC released on 17th February 2010 means that once passed the normal retirement age of an un-crystallised pension plan (typically 60/65 yrs) HMRC will look to include the pension value in your estate for inheritance tax purposes. If assets and the pension exceed the allowance in the UK then IHT will be payable.
This is important legislation for UK and non UK residents because most people believe un-crystallised funds (no cash or income taken) on death will be paid 100% to beneficiaries prior to age 75 years.