For generations pension assets have stood outside the scope of Inheritance Tax (IHT).
In October 2024 the Chancellor announced a sweeping reform to the taxation of pensions on death, potentially shifting billions of pounds a year into the 40% rate of IHT. The UK government has now published their response to the pensions & IHT consultation, together with the initial legislation to go before Parliament.
A further period for comment has been opened to the 15th September (prior to the Budget in October), but for now there are a few key points:
KEY POINTS TO CONSIDER:
There is no change to the plan to apply IHT to pensions from April 2027, where they will form part of your estate. Pensions will no longer be swiftly paid outside the usual slow Probate process, which even for simple cases can drag on for many months.
The complex reporting requirements for an individual’s pensions to make separate communication and returns to HMRC on death has been removed. A slightly simpler process is proposed where the Estate’s executor will manage the reporting and tax payment to HMRC. The government will legislate that Pensions Schemes must promptly provide information, which for many Schemes will be a novel change from their current approach. For those in the unfortunate position of administering the Estate of a loved one, the responsibility and complexity of their task has only grown.
Pension funds can be used to pay IHT, but it appears that the government plan on linking the amount that can be paid to the proportion of the pension as part of the estate. Pension Schemes will now need to issue certificates after liaising with the Executor, each certificate showing the value of the pension as a ‘component’ of the Estate. This is a complex situation which will require both Pension Schemes and HMRC to develop new payment (and refund!) processes within the six-month payment window after death – let’s hope this will run smoothly.
The existing discretionary powers enjoyed by Pension Scheme Trustee’s will remain in place. Might this lead to a tax bill due, even where the estate does not receive the funds within six months, an IHT bill is still due? According to HMRC, yes, though as changing this would lead to ‘Exchequer cost’ they won’t make any changes to this policy.
Inherited pensions will still be liable to Income Tax on death after 75 even where IHT has been applied – potentially leaving to tax rates of 67% should funds pass to descendants in well paid jobs. Retaining this Income Tax charge alongside IHT has moved pensions from one of the most family friendly tax structures to the least in a period of 2 years. This is a frustrating change that will upend decades of prudent saving for retirement.
A welcome change is that Death in Service (DiS) payments will be exempt from IHT even if they are paid via a pension scheme. This will be of particular benefit to those still at work in later life, where the decrease in mortgage liabilities mean that DiS payments can be used to fund retirement spending. Spouses will remain exempt from IHT as before, though will still suffer income tax should death occur after age 75.
The retreats made by the government on welfare payments and the Winter Fuel Allowance seemingly do not apply when increasing taxes.
NEXT STEPS
For those with large pensions there are some important considerations to be made:
- What impact will pensions entering your estate have?
- Will it reduce the Residence Nil Rate Band that allows you to pass your home onto children?
- Have you re-written Wills to include pension assets?
- Can pension funds be directed to those on lower income, whilst those with higher income receive assets from the non-pension estate?
- Are there grandchildren not in work, who could effectively inherit pensions with no income tax?
- Any charitable gifts on death should now be considered from pension funds.
- This might return tax allowances if the estate can be dropped below £2 million.
- Potentially a gift of 10% of the estate could reduce the IHT on the balance down to 36%.
- Does it make sense to take an income from the pension even if it isn’t needed?
- Income taxed at 20% in your lifetime could be better used than the same assets taxed 40% on your death.
- Taxed income can also be passed on through the ‘normal expenditure’ rules – is now the time to start gifting?
The Chancellor has changed the rules. Therefore, those who wish their assets to go to their family must change their plans. If you would like to speak to one of our Chartered Financial Planners on the subject, please do get in touch. We’d be happy to help.
Important Note
The information contained within this document is subject to the UK regulatory regime and is therefore primarily targeted at consumers based in the UK.
This article is distributed for educational purposes only. This communication does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs.
The opinions stated in this document are those of the author and do not necessarily represent the view of Progeny and should not be relied upon to make a financial decision.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
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