Jeremy Goodwin, Partner and Head of Pensions at global top 10 law practice, Eversheds Sutherland, shares his analysis into the recent Budget changes to bring most unused pensions and death benefits payable under registered pension schemes and qualifying non-UK pensions schemes within the value of a person’s estate for IHT purposes from 6 April 2027.
It’s commonly thought that, for any new law to succeed, it should at least be workable, fair, and clear. Since the announcement of the government’s proposal to include unused pensions and death benefits in the Inheritance Tax (IHT) regime from April 2027, questions have been raised about whether the proposed new rules meet these success criteria.
There are three key points that I suggest could helpfully be addressed.
Realistic timescales?
Within the new rules, the proposed timescales for paying and reporting any IHT due (before interest and penalties arise) do not currently reflect the time typically required (a) to determine the beneficiaries and (b) to pay benefits on death within a pensions context.
The current time limit that applies to these payments for income tax purposes is broadly two years from the point at which a scheme becomes aware of a member’s death. In contrast, it is proposed that IHT will need to be paid within broadly six months of the date of death, even though it is often weeks or months (or in some cases, years) before a scheme becomes aware that a member has died.
The challenges in meeting this deadline are compounded by the fact the proposed changes will add extra layers of complexity to the process. Most significantly, pension schemes will be reliant on being given information by a deceased member’s personal representatives, assuming there are any, to calculate and pay the IHT that is due. Delays within this process seem inevitable and could result in unintended hardship, distress, and inconvenience for some beneficiaries.
Decisions over who should receive benefits following a member’s death are among the most contentious trustees can make, often leading to complaints from disenfranchised beneficiaries. If these are then taken to the Pensions Ombudsman, they can take years to resolve.
Based on the current proposals, this would delay the payment of IHT on all of a deceased member’s estate (including by other pension schemes), and could result in substantial interest payments and penalties. Additionally, interest will accrue even if a delay is not the fault of either the pension scheme in question, or the beneficiaries (from whose benefits interest payments will be deducted).
Fair taxes?
In some cases, both IHT and income tax may be payable by the recipient of death benefits, potentially leading to eye-watering effective rates of tax.
If, as proposed, death in service benefits payable under registered pension schemes become subject to IHT, some families could lose up to 40% of the funds they would otherwise have received following the death of a loved one. The purpose of these benefits is to provide financial protection in the event of an untimely death, not to transfer wealth. There is therefore a strong argument for keeping death in service benefits outside the scope of IHT entirely.
Unmarried partners and their families could be particularly vulnerable. While surviving legal spouses or civil partners are exempt from paying IHT, unmarried partners do not benefit from this protection. This raises questions about the justification for this difference in treatment. Additionally, would unmarried couples even be aware that the protection for their family in the event of an early death may be significantly reduced?
The government is also proposing to include dependants’ annuities and drawdown within the IHT scope, even though dependants’ pensions paid through a defined benefit scheme will be excluded. This sparks several questions: How will dependants’ annuities purchased before a member’s death be valued, especially if the recipient dies shortly after the member? Additionally, where will the funds come from to pay the IHT bill if the annuity has already been purchased?
Undue complexity?
Going forwards, trustees and providers with discretion over who should receive a member’s death benefits may face tough choices given the potential tax consequences of their decisions.
For example, a decision to make a payment to a deceased member’s child rather than a legal spouse could lead to IHT being payable when it otherwise would not have been. This could raise additional complaints in an already contentious area.
How individuals will respond to these changes is uncertain. For some, it might reduce the attractiveness of saving into a pension. Savers are also likely to face difficult decisions about how quickly to draw down their pension savings in retirement. Planning for retirement and managing pension savings is already complex enough. These changes will only increase the challenge.
Schemes and employers will want to clearly communicate these new rules to their members and employees. While those who can afford financial advice may well find ways to mitigate the impact, those without access to this advice will face the full impact of these proposals.
Time is of the essence
The good news is there’s still time to address many of these issues and we eagerly await updates on potential changes to the proposals, such as excluding death in service benefits and dependants’ annuities from scope and extending the IHT payment period.
In the meantime, it’s vital HM Treasury and HMRC continue to collaborate with the industry to develop a streamlined process, preventing unnecessary delays in the payment of death benefits, undue hardship for beneficiaries, and unfair interest and penalty charges.
There is also a clear need to address the inherent inequalities within these proposals and ensure savers receive the support they need to help them make informed decisions as they plan for their retirement and beyond.