Highlights
- Today’s Budget brought some good news:
- Despite recent speculation, National Insurance contributions (NICs) will not be charged on employers’ pension contributions; and
- No changes were announced to members’ tax-free lump sums.
- However, changes to inheritance tax (IHT) will provide headaches for scheme trustees and administrators from April 2027. We look at the detail below.
- Tax on transfers to overseas (QROPS) pension schemes is extended from today.
IHT on pension lump sums and unused funds: the details
The Chancellor has announced that inheritance tax (IHT) will be extended to many death benefits from pension funds.
It was widely anticipated that the Chancellor would bring unused defined contribution (DC) funds within the scope of IHT. In a surprise move, however, many other death benefit lump sums will also be included in a member’s estate for IHT purposes, including lump sums from defined benefit (DB) schemes. This aligns with the government’s stated intention to bring pension saving back to its original purpose of providing retirement income for the member (and the member’s spouse or civil partner), rather than as inheritance for the member’s descendants.
Alongside the Budget announcements, HMRC has issued a technical consultation on how applying the new IHT liability to death benefits from pension schemes may work in practice. The government intends to consult on draft legislation in 2025.
HMRC has confirmed that the government will continue to incentivise pension saving, supported by ongoing tax relief on pension contributions and on investment growth within pension schemes.
When will the IHT changes apply?
The changes will apply from 6 April 2027. The standard IHT rate of 40% will apply.
What death benefits will be chargeable to IHT from April 2027?
All authorised death benefits from registered pension schemes, other than a dependant’s scheme pension or charity lump sum death benefit, will be included in the member’s estate for IHT purposes. This means that the following lump sums will be potentially liable to IHT:
- Death in service lump sums
- Pension protection lump sums (such as five year guarantees)
- Uncrystallised funds lump sum death benefits
- Survivors’ annuities or drawdown funds.
At present, where pension scheme trustees have discretion to decide who should receive a lump sum death benefit (with the member being able to express a wish but not to bind the trustees), the lump sum death benefit is held on “discretionary trust” and does not form part of the member’s estate for IHT purposes. HMRC intends to remove the difference in treatment between death benefits held under discretionary and non-discretionary arrangements.
New duties for administrators
From 6 April 2027, pension scheme administrators will be liable for reporting and paying any IHT due on unused pension funds and death benefits. This will mean that:
- The member’s personal representatives (PRs) will not have to use other (non-pension) assets to pay any IHT on pension benefits; and
- Any IHT due is paid direct from the scheme, and is not subject to income tax in the hands of the beneficiary.
How will pension administrators know whether IHT is due?
HMRC expects pension administrators and PRs to liaise, broadly, as follows:
- The PRs inform the pension administrator of the member’s death and request the value of any death benefits from the pension scheme which fall within the member’s estate;
- The pension administrator informs the PRs of the value of any unused DC funds and lump sum death benefits potentially liable to IHT, within two months of receiving the request (this may in practice be challenging – please see below);
- The PRs use the death benefit values to calculate the total value of the member’s estate and inform the pension administrator if IHT is payable;
- If IHT is payable, the PRs use a new HMRC calculator to work out how much of the member’s IHT nil-rate band is apportioned to each death benefit from the member’s pension schemes (taking account of any sums left to a spouse / civil partner, which are exempt from IHT). The PRs share this information with each pension scheme administrator;
- The pension administrator calculates the IHT due on the pension benefit, and reports and pays this to HMRC.
Legislation will provide for the relevant information to be shared between pension administrators and PRs.
The spouse / civil partner exemption: a challenge for pension administrators?
Many death benefit lump sums from private sector pension schemes are held under discretionary trust – that is, the trustees have discretion to decide who should receive the benefit, usually from within a defined group of potential beneficiaries. To exercise the discretion properly, trustees should gather information about members of the class of beneficiaries and consider all relevant factors, before making their decision. Doing so can often take a fair bit of time, especially when dealing with grieving family members who have other immediate priorities.
Discretionary death benefits paid to a spouse or civil partner are wholly exempt from IHT. Where the potential beneficiaries include both a spouse (or civil partner) and others, the pension administrator will not know whether there is any potential IHT liability until after the trustees have decided how to exercise their discretion.
Complying with the two month deadline for informing the PRs of any death benefits within the member’s estate for IHT purposes may therefore be difficult in practice.
When must IHT be paid?
An individual’s PRs must report to HMRC and pay any IHT due within six months of the end of the month in which the member died. Interest is charged on any late payment of IHT.
From 6 April 2027, the six month deadline will also apply to pension administrators, who will be liable for interest if IHT due is paid late.
From 12 months after the member’s death, the member’s beneficiaries will become jointly liable with the administrator for any remaining IHT due on unused pension funds or death benefit lump sums. This is intended to be helpful if the IHT amounts subsequently need adjusting (for example, because additional assets come to light which the PRs did not know about) after the benefits have been paid.
What if the member’s total estate is below the IHT limit?
HMRC forecasts that less than 10% of estates will pay IHT in coming years. Where a member’s estate (the total value of unused pension and non-pension assets) is less than the IHT nil-rate allowance of £325,000, no IHT will be payable. (Where the member leaves their home to a direct descendant, the higher residence nil-rate band (an additional £175,000) may also be available.)
Pension scheme administrators will only be required to report IHT information to HMRC following a member’s death if there is IHT actually payable on unused funds or death benefit lump sums.
What about other pension or life assurance arrangements?
HMRC has confirmed that the IHT changes will apply equally to qualifying non-UK pension schemes.
The penultimate paragraph of the technical consultation states that “life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the IHT changes”. It is unclear exactly which arrangements are meant by this.
The technical consultation does not refer to excepted life assurance arrangements or unregistered (top up) pension schemes. These may be covered in subsequent consultations.
Authored by the Pensions team.
