John Lawson discusses the inheritance tax implications
of retiring abroad.
Before considering the inheritance tax (IHT) implications of retiring
abroad, an understanding of how IHT rules apply to pensions is essential.
In 2006, when the new simplified pension tax rules came into force, HMRC
formalised the concessionary practice that existed beforehand.
In basic terms, a pension fund owned by someone under age 75 will not form
part of his or her estate on death. This is regardless of whether income
withdrawals in the form of an annuity or drawdown have commenced.
An exception to this principle applies to people in serious ill health;
people whose life expectancy is, in the words of HMRC “seriously impaired”.
This is generally taken to imply life expectancy of two years or less.
In such circumstances, HMRC will seek to apply inheritance tax if the
individual failed to exercise a right to take benefits, in the knowledge that
they are seriously ill. In other words, the individual is seeking to preserve
as much value in their pension to pass to their heirs. They might do this by
taking no income or a low income (less than an equivalent annuity payment) from
a drawdown fund.
Even in cases of serious ill health, if the individual’s spouse or dependent
children inherit the pension fund, there will normally be no IHT charged.
If HMRC does seek to include the pension within the estate for valuation
against IHT thresholds, it should be noted that the amount to be included in
the calculation is not the fund value. Rather, HMRC use a complex calculation
to work out the today’s money value of future annuity instalments (on the
assumption that the fund has been used to buy an annuity).
After age 75, HMRC work on the assumption that the risk of death for
everyone is higher, and therefore anyone seeking to preserve as much of their
pension fund as possible is potentially seeking to avoid IHT.
At age 75, people have a choice to either buy an annuity or an alternatively
secured pension (ASP). If they buy an annuity, it is clear that they have
exercised the right to take pension income. But people with ASP should be aware
that any residual fund left to other members of the pension scheme, for
example, non-dependant children (a ‘transfer lump sum death benefit’) is
potentially subject to IHT.
In the case of ASP, it is the full residual fund value that is added to the
estate, rather than the present value of a hypothetical annuity. Again, any
fund passed to a spouse or dependant is exempt. Funds left to charity are also
exempt.
Domicile
Having considered how IHT applies to pensions, the next stage is to consider
whether IHT applies at all. This all hinges on whether the individual’s
‘domicile’ or ‘deemed domicile’ is the UK. If so, then their estate will be
assessed for IHT in the UK.
Domicile is not the same as residency (for say income tax purposes) nor does
it refer to someone’s nationality.
Generally speaking, the UK regards the country where someone has their
permanent home as their country of domicile.
At birth, everyone acquires a domicile of origin. This is normally the same
as the domicile of their father. If their father changes his domicile after
their birth their domicile also changes – this is known as a domicile of
dependency.
Once someone reaches age 16, they are entitled to change their own domicile
– their domicile of choice. In simple terms, they can do this by leaving the UK
and settling permanently in another country. But unfortunately, changing
domicile is not quite so simple.
HMRC will base its decision on whether you have changed domicile upon a
number of factors. Evidence of living in another country, owning property
there, disposing of property in the UK, having family abroad or establishing a
business abroad will all help in convincing HMRC that your domicile is no
longer in the UK.
However, even if the law says that your domicile has changed, IHT
legislation also contains the concept of deemed domicile. This can override
your domicile of choice if you have been a UK resident (for income tax
purposes) in 17 out of the last 20 years, including the current one, or where
you are domiciled in the UK within three calendar years of death.
For UK pensioners intending to move abroad, it is important that they seek advice on these matters before they emigrate. Trying to argue domicile retrospectively, particularly where evidence has not been collected, can prove difficult.
Author: John Lawson
If you are considering retiring abroad and would like financial advice, contact us on 0191 411 1133 or e-mail me at mark@greengem.co.uk