The key pensions announcement in the Budget was that from 6 April 2027 most death benefits from pension funds will be included in the value of a person's estate for inheritance tax (IHT) purposes. Some benefits from an employer-provided scheme will not be caught, but the precise scope of this important exemption is currently unclear. Scheme administrators will be liable for paying any IHT due in respect of pension funds/benefits. The Government says the policy intention is to remove the incentive to use pensions as a tax-planning vehicle for wealth transfer after death. However, it appears that the impact of the measure will be much broader than this.
Which benefits will be affected?
A technical consultation on the measures says that, "All life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer" are not in scope of the changes. Subject to this "employer package" exemption, dependants'/nominees' and successors' annuities and drawdown funds will form part of a deceased member's estate, as will all the main types of lump sum death benefit. Dependants' scheme pensions (the type of survivor pension normally paid from a defined benefit scheme) and charity lump sum death benefits are not caught by the measure.
The scope of the "employer pension package" exemption raises some important questions, particularly in relation to money purchase schemes, which we consider below.
Scheme administrator responsible for paying IHT
The consultation proposes that scheme administrators will be responsible for paying IHT attributable to pension scheme benefits. This will rely on a regime in which the scheme administrator and the deceased's personal representatives (PRs) are required to share information with each other so that the PRs can calculate how much IHT nil rate band is apportioned to each of the deceased's pension schemes. Scheme administrators will be responsible for paying any IHT due in respect of the member's pension fund. The consultation acknowledges that scheme administrators may not have the funds to meet any IHT liabilities that come to light after the scheme benefits have been paid. It proposes that, 12 months after the death of a member, beneficiaries who have received death benefits will become jointly liable with scheme administrators for the IHT.
Will all members be affected?
Currently most estates do not pay IHT. The nil rate band allows all estates to pass on at least £325,000 without liability to IHT. An additional nil rate band of £175,000 may apply in respect of the deceased's residence if the property is inherited by a direct descendant, but the residence nil rate band is reduced by £1 for every £2 that the net value of the estate is more than two million. Inheritances by spouses or civil partners are exempt from IHT, and unused nil-rate band or residence nil-rate band can be transferred to a surviving spouse or civil partner. In many parts of the UK, the value of a relatively modest family home will use up all or most of the nil rate band, so bringing pension benefits within the scope of deceased's estate is likely to trigger substantial IHT charges in many cases where the estate is passing to someone other than the deceased's spouse or civil partner.
Exactly which employer pension packages will be out of scope?
There is no detail as yet on this key question. What is the position for funds transferred into the employer's scheme or funds stemming from additional contributions that the member makes on an optional basis? If the legislation makes a distinction, will scheme administrators necessarily hold records showing how scheme funds were derived? From a policy perspective, we would expect small self-administered schemes to be in scope, but legally a SSAS is an employer scheme.
Will schemes have to make decisions about discretionary death benefits much sooner?
Currently schemes generally have two years within which to make a decision about lump sum death benefits, but the payment deadline for IHT is 6 months after the end of the month in which the death occurs. To know how much IHT is due, scheme administrators will need to know whether the lump sum they are paying is going to be paid to a spouse or civil partner and thus benefit from an exemption from IHT. It therefore appears that schemes may in future need to make decisions on lump sum death benefits in a much shorter timeframe in order to avoid overdue IHT liabilities.
Next steps
The technical consultation runs until 22 January 2025. The Government will publish a response document and carry out a technical consultation on draft legislation in 2025.
Our thoughts
The proposed measures involve a fundamental change to the tax regime which will impose significant additional obligations and liabilities on pension scheme administrators. The impact of the proposals will be felt well beyond the stated target of individuals who use pension schemes as an IHT planning vehicle. Much of the important detail is yet to be worked out. The intention appears to be that schemes provided by employers will not be caught, but the detail of this important exemption does not appear to have been considered, for example the position in relation to transfers in or additional voluntary contributions by members. The proposal to make scheme beneficiaries jointly liable with scheme administrators for IHT could leave beneficiaries in a state of uncertainty regarding whether they can safely spend the money or need to budget for possible future IHT liability. It appears that the measures could in some cases have particularly harsh consequences for the self-employed who do not have access to an employer's pension scheme, particularly where a self-employed person wishes to provide for a dependant other than a spouse or civil partner.
