Unused pension funds will fall under IHT scope from April 2027
The government is ploughing on with its plans to bring unused pension funds into the realm of inheritance tax (IHT) despite a “deluge of criticism” from industry practitioners during a consultation phase during which they put forward alternative options.
The Treasury has today (22 July) released draft legislation to bring undrawn pensions into scope for IHT from April 2027.
AJ Bell head of public policy Rachel Vahey said HM Revenue & Customs (HMRC) had “blown its opportunity to bin the original proposals, stubbornly sticking with a system that will create confusion, complexity and additional costs for bereaved families”.
She explained the government had not listened to the industry despite experts putting forward alternative options which would have been “far more straightforward than bringing unspent pensions into IHT, while still raising the same amount of tax”.
Vahey said, although most savers will be unaffected and should not need to change their financial plans, “some now face difficult choices about how best to arrange their finances”.
“Many have saved and invested in good faith and now face the possibility of punitive rates of taxation when passing pension money to their loved ones,” she commented.
“Bereaved families also face a huge administrative burden, with the government insisting they settle the IHT bill within six months. Many people have complex financial affairs, especially those who die unexpectedly, meaning settling the bill quickly may not be straightforward.
“This change marks a significant shift in the tax treatment of pensions and anyone concerned about the proposals should think about speaking to a professional financial planner.”
The Treasury’s technical consultation, which closed in July, received 649 responses. In light of the consultation, the government made some minor adjustments to its implementation plans.
Vahey explained that instead of pension scheme administrators (PSA) handling the reporting and payment of IHT on unused pension funds on death, this responsibility will shift to the personal representatives (PRs), or executors, of the estate.
“This may alleviate some of the problems with the initial proposal, as beneficiaries might be able to pay the whole IHT bill from other estate assets, possibly resulting in a faster settlement. But it by no means creates a simple process.”
However, she said: “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. 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.”
Seismic shift
Quilter pension specialist Roddy Munro said the changes were more than a “technical footnote” from the Treasury. He described the move as a “seismic shift in how we now think about and plan for retirement and estate planning”.
“While the policy is now settled and financial plans are already beginning to change to accommodate it, the details of its implementation carry significant implications for families, advisers and pension providers,” he said.
“The government has already consulted on the policy and has thankfully listened to some responses.
“For example, a question mark had been left on whether death in service benefits payable from a registered pension scheme would be out of scope, which has today been confirmed.
“Additionally, significant concerns around the proposal to make PSAs liable for reporting and paying were noted within the consultation responses and the government has opted not to proceed with the PSA-led approach set out in the technical consultation document as a result.
“However, without further amendments, how the policy is eventually enacted risks turning a targeted tax reform into an administrative minefield. What we could end up seeing is a massive transfer of private wealth back to the state.
“What’s more, while only a small fraction of estates will pay more tax, a far greater number will face needless complexity, delays, and stress – often at the worst possible time.
“While this certainty brings much more clarity, clients are already acting. Trusts and other legacy planning tools are moving into the mainstream. And while policy will continue to evolve, the need for robust, well-informed advice will be critical.
“As the policy progresses, we will continue to feed into how the government can refine and develop the process for pensions and the payment of IHT. The industry has offered workable alternatives, and it’s time for the government to listen.”
Sackers partner Claire Carey commented: “On the cusp of the summer recess, the government has confirmed that it is pressing ahead with plans to bring unused pensions in scope of IHT.
“From an individual perspective, it is worth bearing in mind that existing exemptions and nil rate bands will mean that the majority of estates will not, ultimately, be subject to IHT.
“However, at a time of increasing regulatory burden, the new measures will impose additional obligations on pension schemes, not least by increasing information flows between them and personal representatives.”
She added: “However, there is some good news. Originally, there was uncertainty around whether death in service benefits payable from a registered pension scheme would be caught.
“Designed to compensate for the loss of an individual’s income at an incredibly difficult time, no doubt to the industry’s collective relief, the government has now confirmed that they will be excluded from its IHT proposals, alongside dependants’ scheme pensions from defined benefit or collective money purchase arrangements.”
Alternative proposals
AJ Bell, alongside other providers, previously campaigned for the government to consider alternative measures which would be simpler and fairer to implement while still achieving the same tax take.
For example, it said income tax applied on withdrawals at the marginal rate of the beneficiary would be a “far simpler alternative and means those inheriting pensions with the highest incomes pay more tax, while also offering simplicity given pension assets are already subject to income tax where the member dies after age 75”.
In January the leaders of AJ Bell, Hargreaves Lansdown, Interactive Investor and Quiltersigned a joint letter to the chancellor’s office opposing the plans.
Earlier this month, TISA and Oxford Economics outlined two models that meet the government’s revenue and policy objectives while avoiding the risk of delays, confusion, and added pressure on bereaved families.
Jenny Brown Professional Adviser