Inheritance Tax on Pensions, ISAs and Offshore Investments

The wrappers used by everyday investors all have differences when it comes to how they are taxed. Many of our decisions on which wrappers to allocate funds to are driven by the desire for tax efficiency during our lifetimes. What happens on death, tax wise, is not always as well understood. This is not an exhaustive overview but rather is intended to highlight some points that may be of use to an investor engaged in estate planning.

Pensions

The good news is that most pensions are not part of an estate for IHT purposes. This is because most pensions are set up to be treated as a ‘settlement’ (which is the legal term for a trust). Many of us are familiar with ‘nomination of wishes’ forms for the pensions we hold. Where a pension is deemed a settlement (trust), the nomination form is asking the trustees to pay the benefits from the scheme to our chosen nominees. As long as this nomination is non-binding on the scheme trustees, the pension will not usually be subject to IHT.

Certain pensions can occasionally be subject to IHT where the payment from the scheme would be deemed to form part of the estate. The two most common examples of this are found in older retirement annuity contracts (also referred to as S.226 plans) and section 32 buyout bonds/plans. If you are unsure of the type of pension you hold or its IHT treatment, a call to the insurance company or scheme administrator should clarify this aspect for you. If you hold pensions which are liable to IHT, there are steps you can take (see below).

IHT can also apply to a pension if you have a known serious ill health condition and contribute to, or transfer from, a pension in the 2 years prior to death.

IHT Pension Planning possibilities:

• Consider assigning to trust pensions which are liable to IHT.
• S.226 and S.32 plans are run by insurance companies. They will often provide any required trust paperwork free of charge should assignment be appropriate.
• Plans subject to IHT can be transferred to other pensions which may be suitable for your needs and offer additional benefits (but check before transfer that no valuable benefits would be lost and be wary if you have a serious health condition).
• Pensions which are deemed as settlements (trusts) are not part of estate value for Residence Nil Rate Band purposes. So, if your estate is approaching or over the £2m taper threshold and you have a pension fund from which you draw income, consider whether drawing income from other sources instead is possible/appropriate to cap/ reduce their value and allow the pension fund to increase.
• Tax relieved pension contributions can be made until age 75 (subject to the ill health proviso) providing the opportunity to increase more tax efficient pensions as part of an overall estate/retirement plan (check your lifetime allowance position first and be wary of the effect of costs on smaller pensions).
• Contributions can be made to a pension in the name of a child/grandchild as soon as they are born. If they have no earnings, the maximum amount is the stakeholder pension cap (£3,600 per annum gross). You would pay £2,880 and the administrator claims £720 tax relief. Even smaller contributions can have a good IHT impact once long-term growth is factored in.

N.B. Occasionally, investors believe that any tax-free lump sum benefit they withdraw from any type of pension remains free of all taxes (because it’s come from the tax-free pension element). Unfortunately, when an investor withdraws any amount from their pension, it is now outside the pension and part of the estate, thus potentially being liable to IHT and other taxes such as income tax and CGT.

Pensions taxation can be a minefield, especially if you are deemed a high earner and/or have a lifetime allowance problem. In any cases where you are in any doubt about the tax position, we suggest you seek specialist advice.

ISAs

Investment ISAs are part of an estate for IHT purposes (the tax-free wrapper only extends to income tax and capital gains tax). It is a common misconception that because ISAs are sold as tax free, this extends to being free of IHT.

Prior to 6th April 2018, ISA benefits would end when the account holder died. Since then, a spouse or civil partner has gained the right to inherit their deceased partner’s ISA funds via the additional permitted subscription rules.

Additional Permitted Subscriptions (APS)

The APS rules do not reduce any IHT payable, they simply allow the value of a deceased person’s ISA/s to be inherited, which their surviving spouse or civil partner can then use to subscribe to an ISA in their own name. The APS value of the deceased person’s ISA/s can be either: the value at the date of death or, the value at account closure. So, if a person died with ISAs valued at £150,000 at date of death which grew to £158,000 by the date of account closure, the spouse/civil partner can choose either value as their APS. (For absolute clarity, it is the ISA value at date of death that is used for valuing an estate for IHT purposes – the choice of dates only applies to APS rules). Each ISA held by the deceased must provide confirmation of the APS applying to it.

The spouse/civil partner can make their APS subscription with any ISA manager that accepts them; however, it should be noted that certain restrictions apply which may influence the choice of ISA manager. For example, if they want to retain the existing investments and use them to fund their subscription to a new ISA (done via an in specie transfer),

the new ISA must be with the same ISA manager where the deceased had held those investments previously. If the spouse/civil partner wants to choose a new ISA manager, the APS subscription can only be in cash.

The new, post-death APS rules can therefore be particularly beneficial for holders of larger ISAs because funds can remain invested and generate tax free returns in the period it takes the estate to obtain probate (usually 6-9 months).

Alternative Investment Market (AIM) stocks held in an ISA

It is possible to invest in certain AIM stocks that qualify for Business Relief (BR) (formerly Business Property Relief and still referred to as such in many IHT publications). If such stocks are held for at least 2 years, then they should be exempt from IHT. It is the BR that makes such stocks free of IHT and has nothing to do with the ISA. However, investors need to be aware that not all AIM stocks qualify for BR and this is a very small, higher risk pool to fish in (unlike the Fundsmith Equity ‘investible universe’, the AIM IHT exempt universe is not filled with high quality, liquid companies). Those that do currently qualify for BR can lose it, e.g., by taking a secondary listing on another exchange. There is no centralised list showing which stocks currently qualify for BR so finding stocks which qualify can be difficult for the layman. If a stock loses its BR status, it would be liable for IHT (although remaining free of income tax and capital gains tax if retained in the ISA). As we always say, no investment should ever be made on the grounds of tax benefits alone, something Terry has written above previously, found here and AIM stocks only held to secure an IHT benefit are a good example.

Unlike pensions, AIM stocks are part of any estate value calculation when looking at the availability of the Residence Nil Rate Band (RNRB) and the £2m threshold for taper.

Offshore Investments

The liability (or not) to pay IHT is based first and foremost on a person’s domicile, not where the investments are located or where the person is resident. Simply living outside the UK and/or having offshore investments does not avoid a liability to IHT if you are UK domiciled. Said differently, a UK domicile persons’ estate will be liable to UK IHT on all assets it owns, even if they are non UK resident.

People who are non-UK domiciled are not subject to UK IHT on investments held offshore. However, they should be aware that they can become deemed UK domicile if they have spent 15 of the last 20 UK tax years as UK residents. Establishing your domicile can be a complex topic and advice should be

sought if you are in any doubt.

If you are a non-UK domiciled and have been advised to keep assets offshore, this is usually because you have chosen to be taxed under the ‘remittance basis’.

Non domiciles choose the remittance basis primarily to avoid paying UK income or capital gains tax on investments held outside the UK. Keeping the assets outside the UK also means they avoid UK IHT until/unless you become deemed domicile in the UK. However, it should be noted that holdings in UK situ unit trusts and open-ended investment companies are deemed to be ‘excluded property’.

In other words, for IHT purposes only, they are looked at as if they are offshore investments and will not be subject to IHT (details here).