The inclusion of defined contribution pension benefits in people’s estates for calculating inheritance tax has really thrown a spanner in the works of estate planning. However, as you will know, I am recommending exercising caution when it comes to making big decisions around taking pension benefits before 2027, when the new rules come into force. There is strong representation against the proposals as they stand, and it is possible there could be amendments before then.
The following is an article on this subject from Money Marketing written by Steve Levin, CEO of Quilter.
“Labour’s decision to bring pensions into the inheritance tax (IHT) framework marks a significant policy shift but also introduces considerable complexity into an already overburdened system.
The challenge now lies in implementing this change without exacerbating existing inefficiencies or undermining trust in long-term financial planning.
While there is no general exemption from IHT for pensions, various provisions in the Inheritance Taxes Act 1984 have exempted pensions in specific circumstances. Since 2015, pension freedoms have offered people greater flexibility in how they take their pension benefits and pass on funds after death, serving as tools for retirement and estate planning.
The suggested IHT change is seen as closing a ‘loophole’, but this implies ambiguity that was exploited, which is not the case.
The IHT treatment of pensions has been fairly consistent, despite some recent clarifications. This change has the whiff of retrospective taxation on those who funded pensions expecting the current IHT treatment.
Altering the rules soon after pension freedoms were introduced risks undermining savers who made decisions based on the current framework. Individuals later in life may not have the scope to replan based on this cliff-edge implementation without transitional provisions.
Under the current proposals, there could be eye-wateringly high levels of taxation. Applying 40% IHT and then income tax (possibly at 40% or 45%) leads to marginal rates of 64% or 67%. This can get more extreme if pension assets push an estate over £2m, removing the residence nil-rate band.
It is unconscionable to tax remaining pension funds at levels that could remove their value almost entirely.
HM Revenue & Customs has been tasked with designing the process to implement the change, including how IHT due on pensions will be calculated, reported and paid, and how information will be exchanged between pension schemes and legal personal representatives.
The process, outlined in the technical consultation, appears to create concerning outcomes. It will inevitably increase the time taken to pay out death benefits. The probate process, already struggling with delays, will face further strain.
This growing backlog is causing significant stress for grieving families, who often cannot access key assets until probate is granted. Executors face a time-consuming process of gathering information, valuing assets and submitting forms. Adding pensions into the IHT framework will increase this administrative burden, risking further delays.
Pension schemes are often unaware of a member’s death immediately, delaying the start of legal and tax processes. Legal personal representatives, tasked with consolidating information across multiple pension schemes, will face an even greater burden. For grieving families, these delays and added responsibilities compound an already difficult situation.
The proposed introduction of a tool to generate nil-rate band statements for pension schemes may help streamline the process, but it is not a straightforward solution.
Personal representatives would need to input detailed information, adding complexity to an already time-intensive task. Pension schemes will have to decide whether to continue with discretionary processes for identifying beneficiaries, which can add significant time.
Delays may also cost families significantly. HMRC proposes charging interest on IHT owed after six months following death, currently at 7.25%. Interest will likely be charged on IHT due from schemes even where delays are not caused by them, quickly mounting up.
Ambiguity persists around what pension benefits fall within the new rules, such as death in service benefits or joint-life annuities. Including such annuities could involve actuarial calculations similar to those for annuity guarantee periods.
Alternative solutions may exist that could be palatable to the Treasury, avoid excessive tax rates, and allow beneficiaries prompt access to funds without diminishing the attractiveness of pensions. We hope that HM Treasury and HMRC are open to collaboration on this matter, and we are currently developing suggestions for consideration.
The risk of repeating the mistakes of the previous government’s hasty abolition of the lifetime allowance cannot be overstated. Poorly thought-out reforms create administrative headaches and undermine trust in the pensions system. Tax rules are already highly complex, and any changes must aim to simplify rather than complicate the system further.
While reforming the IHT treatment of pensions might generate much-needed revenue, it must be approached with care.
The government’s fiscal ambitions are understandable, but pensions are fundamentally long-term products. Sweeping changes, especially on an accelerated timeline, risk damaging the system’s stability and penalising those who planned their estates in good faith under existing rules.
By adopting a pragmatic and phased approach, the government can ensure the system remains fair, operationally feasible and supportive of the nation’s savers.”
It is possible this representation may fall on deaf ears, but let’s hope not.
I hope you found the above interesting. As always, if you have any questions about this piece or any other finance-related matter, please do not hesitate to contact me.
Yours sincerely,
