Pension inheritance tax paperwork nightmare – how to prepare to avoid penalties
Pensions will be included in inheritance tax calculations from April 2027 and your executors will have to shoulder the burden of finding all your unused pots. Here’s what you need to know.
The government will apply inheritance tax to unused pensions on death from April 2027, despite significant opposition.
The responsibility to track down all of the deceased person’s pensions will fall to the estate’s executors – also known as personal representatives. If, as many people do, you choose an executor from your family, it could mean your loved ones are left playing detective.
They won’t have much time to locate all the unused savings – the government is insisting they settle any inheritance tax bill within six months. Miss the deadline and penalties of between £100 and £3,200 apply.
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Rachel Vahey, head of public policy at AJ Bell, said: “Bereaved families face a huge administrative burden. Many people have complex financial affairs, especially those who die unexpectedly, meaning settling the inheritance tax bill quickly may not be straightforward,” she added.
Beneficiaries might be able to pay the whole IHT bill from other estate assets, possibly resulting in a faster settlement. But it is still by no means a simple process under the new rules.
“Bereaved and grieving families will still have to grapple with the additional complexity and confusion caused by adding unspent pension funds into the IHT liable assets,” said Vahey.
“Rather than saving them from a tortuous process, this feels like HMRC is doubling down by pushing even more problems firmly onto the plate of the bereaved to solve.”
We look at ways to reduce your IHT bill and avoid inheritance tax altogether in separate articles.
What are the latest rules for personal representatives?
The government has now released some further details of how the policy will work in practice for those left behind to deal with the severe admin headache.
On 11 May, HMRC published a technical note giving some clarifications on how inheritance tax on pensions will operate on deaths from 6 April 2027.
But the tax office plans to provide further information between now and next April. The final guidance is only expected in Spring 2027 – just weeks before the new system comes in.
This could leave pension schemes struggling to update pension holder communications and information ahead of the go-live date.
The foundation of the new system is that from April 2027, unspent defined contribution pension pots will be included in inheritance tax calculations.
Key points on which some further details have been provided, include that a personal representative (PR) will need to track down all of a deceased person’s pensions and contact each pension scheme or provider.
The pension scheme will need to provide information on the value of the pension and who is due to receive the money. Transfers to spouses and civil partners who are long-term UK residents will remain free of IHT.
It will be the job of the personal representative to combine this information with information about the rest of the estate and use a new online HMRC tool to work out what IHT is due (if any). If IHT is due, the personal representative will need to notify each pension scheme of their share of the IHT bill.
To make sure that there is money available to pay the IHT bill, the personal representative will be able to instruct pension schemes to withhold up to 50% of the pension until the IHT bill has been settled (a withholding notice), or until the month-end after 15 months has passed, if sooner.
The government expects his withholding power will often be used quite early in the process, but should only be used where the personal representative has ‘good reason’ to think that IHT will eventually be due.
Further details in the recent update include that:
- The personal representative – and any beneficiary of the pension – will be able to instruct the pension scheme to pay IHT directly to HMRC on their behalf.
- If there’s no will, someone who expects to be the personal representative may, with evidence, issue a withholding notice.
- The personal representative can only issue a notice if they believe inheritance tax may be due on the estate including the pensions, “based on the knowledge of the deceased’s estate and circumstances”.
Tim Camfield, principal at pension consultants LCP said: “There is helpful clarity here for bereaved families that half of the pension should generally be able to be paid out quickly. Pensions have often been a vital source of income for families following a death as they are outside the estate so can be accessed quickly. The estate – and from April 2027 the other half of the pension too – can often be in limbo for far too long for beneficiaries.”
But Camfield is concerned about the impact of delays in more detailed guidance until spring 2027, just weeks before actual cases begin to arise.
“Time is running out for HMRC to give [pension] schemes the detailed information which they will need to implement a new system which starts in less than a year’s time”, he said.
How to prepare your estate for pension inheritance tax rule changes
Getting ahead of the incoming changes now is the best way to prepare your estate so your loved ones – or whoever is the executor – have less of an admin nightmare when you die.
Former pension minister Steve Webb, who is now partner at pension consultancy LCP, said his three top tips on how to avoid an inheritance tax pension paperwork headache are:
1) Keep your paperwork
This way if a loved one has to deal with your affairs after you have gone, there’s a chance they will be able to identify the pension schemes of which you were a member, and know your policy numbers to make tracking them down easier.
2) Create your own pension identification document
Some people go further and produce a short document that can be easily found which will give their executor and heirs useful information about all of their financial affairs.
Pension provider Royal London has created a handy template document called ‘When I’m Gone’, which allows people to provide all sorts of details about financial matters as well as funeral wishes, location of their will and other important information.
3) Consider a financial power of attorney
Getting a financial power of attorney in place now could help. Once you are dealing with someone’s estate it will be before you have probate, so financial institutions may be wary of even giving you information.
But if you can show you already had financial power of attorney for the deceased this can sometimes make them much more willing to deal with you.
What executors will need to do after you die
In terms of the new regime for pensions and inheritance tax, the first step will be simply to locate all the pensions.
“Although in principle you have to contact all of the pension providers and schemes, it’s the defined contribution or ‘pot of money’ pensions which are key,” said Webb.
In many cases these will be run by household name insurance companies, so Webb says if there’s no paperwork, a good place to look is bank statements for things like one-off withdrawals (eg from a drawdown account) or (for younger deaths) regular direct debits to collect premiums.
If the individual had a financial adviser then they should be contacted. They should have a full picture.
HMRC has promised various online tools and calculators to help you work out what is due (if anything) and from whom.
In most cases there is unlikely to be an IHT bill, but you still have to gather all the information to make sure.
