One of the headline announcements in Labour’s first budget in October 2024 was that from 6 April 2027, the value of unused pension funds held by an individual on death will become liable to IHT. This will have a significant impact on the financial legacy many people wish to leave their family and introduce a number of administrative complications for executors and pension scheme administrators.
Present Situation
For most people, private pension savings currently sit outside of their estates. This has two main implications. Firstly, the value of the pension fund held on death is not liable to IHT. This means the full value can be left for the benefit of family or friends. Secondly, as the funds do not form part of a person’s estate, a person’s will has no bearing on who the pension is left to or how much they inherit. This aspect is instead handled by an individual notifying their pension scheme administrators of who they would like to receive their unused pension funds when they die.
If somebody dies before the age of 75, the people they have nominated to receive their pension funds will be able to take the money from the pension completely free of tax. If the deceased died when they were 75 or over, their nominated beneficiaries will need to pay income tax at their marginal rates on any withdrawals they make from the pension fund.
Changes
From 6 April 2027, the value of unused pension funds will be brought within the scope of IHT.
There are currently no proposals to change how people leave their pensions on death, so it should continue to be the case that this is dealt with by nominating beneficiaries with your pension scheme administrators rather than including a legacy in your will.
The current IHT rules should apply to calculating IHT liabilities. This will mean pensions funds left to spouses or civil partners will be exempt from IHT.
Pension funds left to anybody else may suffer an IHT liability. At present, it looks like this will be calculated by adding the value of the pension to the other estate assets and calculating the IHT liability on the estate as a whole. This IHT liability will then be split proportionally across the estate. In simple terms, this should mean the IHT relating to the pension fund will be calculated as:
(Value of pension fund / Total value of the estate) x Overall IHT liability
The IHT liability attributable to the pension fund will need to be paid by the pension scheme administrators from the pension funds.
Potential Issues
Under the current rules, the responsibilities of an estate’s personal representatives (executors) with regards to pension funds extend no further than notifying the pension scheme administrators of the death. It is then left to the nominated beneficiaries to “claim” their inherited pension entitlement, which the scheme administrators can start paying to them when they have satisfied themselves of the claimant’s entitlement and performed the necessary identity checks.
However, this process is set to become considerably more difficult when pension funds are brought within the probate process. The responsibility for paying the IHT due on unused pension funds will lie with the pension scheme administrators and they are unlikely to be willing to make any payments to beneficiaries until they can be sure they have discharged themselves of this responsibility. This will inevitably mean delays for beneficiaries as they wait for executors to finalise the IHT liabilities on an estate with HMRC.
Tax Consequences
Bringing unused pension funds within the scope of IHT may also result in double taxation where an individual dies after the age of 75, with both IHT being levied on death and income tax at rates of up to 45% becoming due on subsequent pension withdrawals.
For example, if a father left £100,000 of unused pension funds to his son who is a higher rate (40%) taxpayer, the amount left to the son following withdrawals would be as follows:
In this example, just 36% of the original pension fund is available to the son, with HMRC taking the remaining 64%!
