At the Autumn Budget on 30 October 2024 the Chancellor produced at least one rabbit out of the hat: on a member’s death, any unused pension funds and death benefits will be subject to inheritance tax (IHT) from 6 April 2027. However, this is subject to consultation on how the proposed changes will work.
| Key Point: Although the principle is clear, there is much water still to pass under the bridge due to the many complexities involved. |
What is changing?
On a member’s death, benefits may be distributed under a pension scheme, for instance, in a defined contribution scheme, this could include the accrued value of the member’s pension not yet received and/or a separate lump sum death benefit. In a defined benefit scheme, typically a multiple of the member’s final salary is payable.
Until now, where scheme trustees have discretion to choose the recipient(s) of the death benefit from amongst a class of potential beneficiaries specified in scheme rules, no IHT is usually payable. This is because the member’s estate is not entitled as of right to the lump sum.
Going forward from 6 April 2027, the existence of discretion will of itself no longer protect the unused pension fund and death benefits from IHT.
Are there complexities?
Yes, numerous including:
Timing – upon a member’s death, the executors must inform the scheme trustees, who shall then have 2 months to notify the executors of any unused pension funds and death benefits payable under the member’s various schemes. These include schemes to which the member actively belonged immediately before death, as well as schemes to which the member previously belonged under which the member has death benefits. Under the proposed changes, scheme trustees will have 6 months from the end of the month in which the member dies to pay any IHT due on pension funds to HMRC or interest on the late payment will start to run.
IHT Nil Rate – the member’s available IHT Nil Rate Band (a maximum of £325,000) and, if available, the Residence Nil Rate Band (currently £175,000) may help to reduce or eliminate the overall IHT in some cases, but many estates will be well in excess of any available IHT Nil Rate Bands. In any event, the Government proposes that the Nil Rate Band be apportioned between the member’s own estate and the pension funds subject to IHT, according to their respective values. Late payment interest is payable on any IHT paid later than 6 months from the end of the month in which the member dies. Subject to any subsequent base rate changes, the current late payment interest rate is 7.25%, rising to 8.75% from 6 April 2025 – another surprise in the Autumn Budget.
Spouse exemption — insofar as the deceased’s own estate and/or the member’s pension scheme “estate” passes to the member’s surviving spouse, an IHT exemption applies. However, there may be no surviving spouse or, where there is a spouse, it may be the scheme trustees divide the pension benefits between the spouse and any children. In difficult cases, distribution decisions within 6 months may not be practicable. Most scheme rules permit up to 2 years for a decision.
| Key Point: The proposed IHT interaction between the member’s estate and the member’s pension scheme benefits could be potentially complex and it may take time to estimate the IHT payable by each. Once 6 months has gone by, late payment interest runs on unpaid IHT. |
The government proposes that after 12 months from the member’s death, any liability for unpaid IHT on the pension scheme becomes a joint and several liability of the scheme trustees and the recipient beneficiary respectively. In our view, this is of little assistance as the pension scheme trustees essentially remain on the hook.
Scope of pension schemes caught for IHT
The proposed extension of IHT presently relates only to registered pension schemes and QNUPs (Qualifying Non-UK Pension Schemes).
Whilst most schemes are registered pension schemes, some are unregistered. Whether the Government intend also to tighten the IHT net for unregistered schemes is unclear.
Not all death benefits are caught as HMRC’s Consultation envisages that where “life policy products have been purchased with pension funds or alongside them as part of a pension package offered by the employer”, such products are out of scope of the present IHT proposals. However, the exact scope of this exclusion is unclear.
Dependant’s scheme pensions are outside the new IHT charge as are charity lump sum death benefits where these can be paid.
Double whammy?
It is proposed that IHT will, from 6 April 2027, apply to unused pension funds and death benefits at the rate of 40% (subject to available exemptions and reliefs). Where the member dies on or after age 75, the income tax charge at the recipient’s marginal income tax rate applies to the net amount paid to the recipient after IHT. This potentially heavy tax burden may well mean re-evaluating pension and estate planning.
Is legislation imminent?
No, HMRC’s present Technical Consultation on its IHT proposals closes on 22 January 2025. After that HMRC will further consider the detail of its proposals. Eventually provisions will be included in a future Finance Bill.
A wave of comments is likely from the pensions industry in response to HMRC’s present Consultation. Wedlake Bell’s Pension Team and Private Client Team have the proposals under the microscope and will be in a position to advise clients once HMRC’s proposals are more developed. Meanwhile, if you have any queries, please contact your usual WB adviser.
Summary – The simple concept of extending IHT to the registered pension scheme world hides a host of difficulties. It seems unlikely the proposal will disappear but one can at least hope for some sensible changes for the benefit of pension scheme trustees and executors, and scheme members and their heirs.
This article is for general information only and does not seek to give legal advice or to be an exhaustive statement of the law. Specific advice should always be sought for individual cases.