Industry experts are calling for significant reforms to the process through which inheritance tax will be applied to pensions, calling for a fairer and more humane approach to the reform.
Pensions are currently exempt from inheritance tax (IHT) calculations, meaning that the value of a pension does not apply to the nil-rate band or the total value of an estate that is taxed for IHT.
But chancellor Rachel Reeves announced in last year’s Autumn Budget that inheritance tax will apply to pensions from April 2027.
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Former pensions minister, Steve Webb, is calling on the House of Lords to revise the planned process through which pensions are included in IHT calculations, and giving evidence today (3 November) to The House of Lords Economic Affairs Committee’s hearing on the Finance Bill and changes to IHT.
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Webb, who is also a partner at consulting firm LCP, and Alasdair Mayes, head of pensions and tax at the firm, have written a joint statement calling on the inquiry to enact the changes which they argue will make the process “more effective, efficient and – frankly – humane”.
“The new regime will create a lot more work both for personal representatives dealing with estates and for pension schemes and providers,” said Webb. These complications could delay payments to both grieving families and the taxman.
“This is already a difficult time for families, and they will now face a ticking clock of six months before interest and penalties could apply if IHT is not sorted out.”
Bringing pensions into the purview of IHT is already controversial. Research from wealth manager Saltus revealed in October that a third of people are actively exploring strategies to protect their pension from IHT, while 30% are reviewing or adjusting their pension savings or retirement planning ahead of the change taking effect.
“The decision to bring pensions into scope from 2027 has really sharpened focus on long-term planning,” said Alex Pugh, financial planner at Saltus. Pugh added that many Saltus clients are asking questions about whether or not the tax rules could change again in the upcoming Budget.
But the team at LCP argue there are major wrinkles in the proposed system that need to be ironed out first.
What changes are being proposed to the pensions IHT process?
LCP’s proposal wants changes to be made that makes the process fair and efficient, and to serve its stated purpose of closing direct contribution (DC) pensions as a means of avoiding IHT. These include:
Excluding ‘death in deferment’ lump sums and funeral payments from the IHT net.
The justification for the policy of including pensions in IHT calculations is that DC pensions had been used by some as a vehicle to avoid IHT. But Webb highlights that the proposed changes go far beyond DC contributions and ‘death in deferment’ lump sum payments – the pensions of people who have left the company providing the plan and have died before starting to take their pension – as well as funeral grants out of pension schemes.
“Given that neither of these systems is being used to avoid IHT, it seems unfair to catch them in the scope of the policy,” said Webb.
Ensuring personal representatives aren’t unfairly exposed.
Under the framework as it currently stands, personal representatives will be liable for ensuring that IHT is paid, but in the case of pensions, they may not have direct control over some of the funds.
“One example would be a pension pot payable to a beneficiary who is not the personal representative,” said Webb.
Webb suggests that solutions to this problem could be to ensure representatives are only liable for IHT due on the rest of the estate, or giving them the power to require the pension provider to deduct IHT before paying out.
A fairer approach towards payment delays.
Representatives are responsible for ensuring IHT is paid within six months, and beneficiaries could be exposed to interest and penalties if this deadline is missed.
“But they may be penalised for matters beyond their control, such as delays in obtaining information about fund values and about other beneficiaries,” said Webb. “Ideally a longer deadline or at least waiving the penalties and interest would seem appropriate in such cases.”
Addressing potential payment delays.
Bringing pensions into the scope of IHT could lead to a delay in payments to legitimate beneficiaries.
“Under the new rules, it’s not clear assets can be paid until the whole process has been completed and the personal representative knows the value of all pension and non-pension assets and how these are to be split between exempt and non-exempt beneficiaries,” said Webb.
“This means that even a payout to a spouse – where no IHT can be due – could be put on hold for months. It would be better if such payouts could be released before IHT matters were resolved.”
Addressing delays in information.
“Given the time pressure on this whole process, more needs to be done to ensure that pension schemes become aware of the death of a member as soon as possible,” said Webb.
He proposes allowing the government’s ‘Tell us Once’ service to share information with pension providers, or requiring registrars to share data about deaths faster and more frequently.
LCP also proposes reducing the ‘end-to-end’ delay of the entire process by allowing probate applications to be processed in parallel with IHT assessments.
Help bereaved families track down pensions.
Finally, it could be difficult for bereaved families to track down pensions, which could further delay the process of assessing the estate.
“Once the new pensions dashboard is up and running it should be made available to bereaved families, and the data displayed should be expanded to include unspent pension balances,” said Webb. “This would be of great assistance to those trying to locate all of someone’s pensions following a death.”
