Yesterday's Budget included a major adverse change to the tax treatment of UK registered pension schemes. It may well mean that employers look to change how they provide life assurance (or death benefits). Pension scheme rules may need changing, but some schemes may not allow those changes without procedures such as statutory consultation, trustee consent or member consent. The tax law changes are due to be introduced in April 2027.
It has been a consistent feature of UK pension schemes that lump sum death benefits are free of Inheritance Tax. The Chancellor yesterday announced that that position will be changed and that all death benefits, except for defined benefit dependants' pensions and lump sum death benefits paid to a charity, will become part of deceased scheme members' estates and will thereby become subject to Inheritance Tax from 6 April 2027 (if the value of the estate goes over the £325,000 threshold for Inheritance Tax). This change will apply to both defined contribution (DC) and defined benefit (DB) schemes.
Lump sum death in service benefits of multiples of annual earnings and lump sum death in retirement benefits of up to 5 times' the deceased member's pension will become subject to Inheritance Tax under the changes, as well as unused DC pension funds where a DC pension arrangement has been in drawdown or designated for drawdown or simply left in the scheme. The value of such benefits is likely to take an increasing number of individuals' estates over the £325,000 threshold for liability for Inheritance Tax. The Government are consulting on the changes, and the consultation is open until 22 January 2025, but the consultation is limited to the procedures for reporting and paying the Inheritance Tax on death benefits. The Consultation document includes a statement that life policy products held through or in conjunction with pension schemes as part of the employer's benefit package are outside the consultation. It is not clear whether this means that such life policy products will be exempt from Inheritance Tax.
We would recommend that, well in advance of April 2027, employers review the death benefits which they provide through their pension schemes, in view of this adverse change to their tax treatment. It may be possible to continue to provide lump sum death benefits free of Inheritance Tax through insurance policies. Such change will need to align with insurance renewal dates.
Employers should note that pension provision in general retains significant tax advantages. Employers' contributions remain free of National Insurance Contributions (at their increased rate) and deductible for corporation tax purposes and employees retain their tax relief on employee contributions and the option for tax free cash at retirement.
If employers are proposing changes to death benefits under pension schemes, pension trustees will need to consider whether, for example, a scheme rule amendment may be validly made removing death benefits from schemes, including for past service. Trustees will also wish to be satisfied that their scheme administrators will be able to fulfil their new responsibilities from April 2027 to report and pay Inheritance Tax on death benefits under UK registered pension schemes. If administrators do not meet those new obligations on a timely basis, individual beneficiaries of deceased scheme members could become personally liable to pay the Inheritance Tax.
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