The End Of The Pension IHT Exemption: Key Changes From April 2027

Pension funds have long enjoyed a favourable status for UK Inheritance Tax (IHT). Most registered pension schemes are discretionary and outside the scope of UK IHT.

Traditionally this has resulted in pensions being a very efficient method of passing wealth to beneficiaries who are not exempt from IHT, such as children. However from 6 April 2027 remaining funds within a pension on an individual’s death will form part of the deceased individual’s estate for IHT purposes.

The new process

Under the new rules, personal representatives (PRs) will have the primary responsibility for reporting and paying the IHT attributable on pension assets even though the pension assets will be outside of the PRs’ control and passing separately to the estate.

Under the proposed rules, PRs would request a pension valuation and beneficiary details from the Pension Scheme Administrator (PSA) following a member’s death. The PSA must provide the valuation and beneficiary information within set timescales, and where IHT is anticipated, PRs can require the PSA to retain part of the pension fund (up to 50%), with the withholding arrangement lasting for up to 15 months from death. Importantly, there does not appear yet to be any timeframe for the trustees of the pension fund to determine the beneficiaries of the fund; the proposed statutory deadlines relate only to the sharing of information before and after that determination has been made.

Once the IHT on the estate and pension has been calculated, the PRs will issue a payment notice to the PSA. Payment date of IHT currently remains unchanged – interest of 4% above Bank of England base rate will start to accrue on any unpaid tax from the end of the sixth month after death. It is widely agreed that completing the above process is going to take considerably longer than six months. However, HMRC is currently standing strong on this point. Early action is going to be key to achieving this timeframe.

Risks for PRs

HMRC have issued guidance that PRs must take reasonable steps to identity pension arrangements. PRs will therefore be expected to make enquiries in relation to potential pensions – an area which might be somewhat tricky, particularly following the introduction of auto-enrolment in 2012 which created small pension pots scattered amongst numerous providers with a very limited paper trail.

As the PRs have the responsibility for locating and declaring the pension assets alongside calculating the pro-rated allowances and attributable IHT, the time investment in administering an estate is going to be significantly increased.

There has been significant commentary highlighting this additional responsibility for PRs has hugely diminished the scope for a layperson to act as PR and administer an estate. Navigating the changes is going to be complex even for the most experienced of PR and reliance on professional assistance is likely to be required in many more cases to ensure a PR meets their obligations. As the responsibility for filing and payment of the IHT rests predominantly with the PR, the estate will incur the legal fees to the advantage of the pension beneficiaries – an issue which will no doubt be the instigator of some future conflict.

What about IHT reliefs?

Draft legislation restricts assets within a pension from benefitting from agricultural relief (AR) and business relief (BR) as the underlying asset is considered as held by the scheme rather than the individual and is therefore ineligible for the relief.

Business owners who hold a business premises within their pension from which they trade should consider whether this remains the most tax efficient way of holding the premises.

In addition, shares and investments personally owned by a deceased individual will be eligible for loss relief if sold within 12 months of death at a loss. Loss relief is not available when such investments are held within a pension scheme.

Liquidity issues within a pension

Many pensions will hold assets which are difficult to liquidate – for example business premises or certain investments. The IHT on these pension assets remains due at the end of the sixth month from death failing which interest will be applied. Whilst the instalment option may be available on some assets, the interest charges will quickly mount up.

For pension structures containing assets difficult to liquidate, both the PSA (particularly if a payment notice has been served) and PRs are going to be in a complicated and difficult position. This scenario would get even more complicated when the beneficiaries of the estate and the pension are different.

If, due to illiquidity, other pension assets which are sitting with a loss have to be sold, as outlined above, loss relief will not be available.

Planning points to consider

Whilst planning will always be based on individual facts and circumstances, some key points to consider at this stage:

• If a pension scheme holds assets subject to BR or AR, consider whether the pension remains the best option to hold such assets.
• Review pension nominations to ensure they are up to date and in line with your wishes;
• If your estate planning has been structured to capture the 36% IHT rate, you should review the position. Your pensions will now be brought into account when calculating the sum which will need to pass to a charity to capture the reduced rate.
• Consider the liquidity within a pension scheme to ensure the IHT can be met and interest mitigated. If there is insufficient liquidity, consider what funding options would be available and what could be put in place.

• Where possible, an individual should help their PRs by documenting all the pensions they have. At the present time, there is no easy and reliable way for a PR to track down all pensions. Whilst a Pension Dashboard is looking at being introduced, which will involve mandatory registration of a significant number of pension schemes, this will not capture the smaller pensions and isn’t expected to be fully operational for a number of years.

Practical tips for PRs

• Proactive communication with the pension beneficiaries will be important, particularly when there is a mismatch between estate and pension beneficiaries, or a pension with limited liquidity. Managing expectations will be key for PRs
• IHT clearance will be fundamental to protect the PRs from potential future liability if a later pension pot, previously undeclared and unadministered, is found. This clearance will however only fully protect the PR if ‘reasonable’ enquiries were made in relation to pensions in the first place
• PRs should be aware of the timeframes for communication between PSAs and PRs to ensure valuations, withholding notices and payment notices are issued and dealt with promptly and correctly.