The Chancellor’s Budget, announced on 30 October 2024, included a statement that unused pension funds and death benefits would be included within the value of a person’s estate for IHT purposes from 6 April 2027, and that pension scheme administrators will become liable for reporting and paying to HMRC any IHT due on pensions.
Consultation
HMRC has issued a technical consultation to seek views on the processes required to implement these changes. The consultation will run from 30 October 2024 until 22 January 2025. The full consultation can be accessed here.
Types of Registered Pension Scheme
There are 2 main types of registered pension scheme. These are:
- defined contribution (DC) – a pension pot based on how much is paid in. Pension contributions are held as investments by the scheme and provide a fund from which pension benefits can be paid. They can be workplace pensions (arranged by employer) or private (arranged by member)
- defined benefit (DB) – usually a workplace pension. Members receive a set amount of benefits, often determined by their salary and length of service rather than the amount paid in
What Happens When a Pension Scheme Member Dies
When a pension scheme member dies, the pension scheme rules will determine who receives any unused pension funds or death benefits. In DC schemes, any unused scheme funds are normally able to be passed on and paid out to beneficiaries in the form of death benefits. DB schemes do not have a dedicated fund which can be inherited, but there may be specific death benefits which become payable, such as a lump sum death benefit or a set amount of pension to a spouse or other dependant.
In many cases, the scheme rules provide that the pension scheme trustees have discretion in deciding who will receive the death benefits. Scheme members can usually nominate who they would like to receive any death benefits, but the scheme trustees are generally not obliged to follow the member’s wishes. These are referred to as discretionary schemes.
In other schemes, the rules provide that the scheme member can choose who will receive the death benefits, and the scheme trustees or manager has no discretion so must follow the scheme member’s directions. These are referred to as non-discretionary schemes.
Existing IHT Rules
Most UK registered pension schemes are discretionary and are therefore currently outside the scope of Inheritance Tax. Existing rules provide that unused pension funds and death benefits from discretionary schemes do not form part of an individual’s estate and are therefore not chargeable to IHT.
For non-discretionary pension schemes, making the Executors liable for payment of any IHT due on a pension can create liquidity challenges if the Executors do not have access to the relevant pension funds. The Executors are often not the actual beneficiaries of the pension, and so will have to use other assets in the estate to pay the IHT due on the pension element. In these cases, Executors can seek reimbursement directly from the actual beneficiary of the pension funds or death benefits.
If the beneficiary draws down the inherited pension to reimburse the Executors for IHT, they may then also be liable to pay Income Tax on those funds at their own marginal rate. This can lead to a situation where an additional Income Tax charge arises on funds which have already been subject to IHT.
Effect of the New Rules
From 6 April 2027, when a pension scheme member dies with unused funds or without having accessed all of their pension entitlements, those unused funds and death benefits will be treated as being part of that person’s estate and may be liable to IHT. The current distinction in treatment between discretionary and non-discretionary schemes will be removed.
The change will apply to both DC and DB schemes, as well as to UK registered schemes and QNUPS. This will ensure that most pension benefits are treated consistently for IHT purposes, regardless of whether the scheme is discretionary or non-discretionary, DC or DB.
Only two categories of specified pension benefits will remain outside the scope for Inheritance Tax, signalling a comprehensive shift in tax treatment. Annex B of the consultation provides a full statement of the types of pension benefits which the government proposes will be in and out of scope of IHT under the new rules.
Strategic Considerations
- Impact on DC Pensions: Historically IHT-free, these pensions will now contribute to the estate value, prompting clients to rethink their pension strategies. For clients over 75, the timing of withdrawals and the structuring of pension benefits are now crucial to minimise tax exposure.
- Transitional Rules: The consultation introduces transitional measures for clients already drawing down or passing on pensions. Advising clients nearing age 75 on withdrawing benefits or transitioning to alternative strategies could help mitigate tax impacts.
- Standardised Valuation: HMRC proposes simplified valuations, which should make estate calculations clearer for Executors. Ensuring accurate reporting, however, may still require close co-ordination with administrators and financial advisers, especially for complex pension holdings.
- New Reporting and Administrative Demands: With added reporting obligations on pension administrators, practitioners should be preparing clients for even more potential administrative delays in probate. Working with administrators early on may help mitigate these.
- Advising on Wealth Transfer: Given the broad inclusion of pension benefits, clients with significant pension assets may wish to consider gifts or trust-based strategies earlier, especially for beneficiaries over 75, to avoid accumulating a larger estate tax bill.
This consultation highlights the importance of pro-active estate planning, particularly around pension usage. For those impacted, thoughtful planning and timing will be essential.
If you would like to talk through any of these issues with one of our specialist advisers, please book an initial consultation with our Head of Private Wealth, Jane Whitfield, by calling 0800 086 2929, emailing info@elitelawsolicitors.co.uk or by completing our Free Online Enquiry Form.
