The practical implications of pensions becoming liable to IHT, and things to consider now!

From April 2027 the value of the majority of pension funds will form part of an individual’s estate for Inheritance Tax (IHT) purposes.

What might be less well known is how the administration of pensions and IHT will work on death. This may well change before next year, but as things stand a large burden of the administration will fall on the deceased’s personal representatives (‘PRs’) who will be responsible for:

• reporting the value of pension death benefits (after first informing all the relevant pension scheme administrators of the death);
• valuing the entire estate – pension funds and non-pension funds – and calculating the IHT due; and
• paying the tax to HMRC.

As with broader IHT rules, tax is generally due within six months of death, after which interest may apply.

There are a number of potential challenges with the process as outlined above:

1. Tight timescale to pay IHT:

IHT is due within six months, a period within which pension benefits may not have been paid out or even fully valued. If the pension scheme has discretion as to who to pay the funds to (as most do), it may not even be clear who should receive the funds, and, if a beneficiary is exempt (a spouse), no IHT is payable, further complicating the process.

2. Understanding the pension structure:

While modern workplace pensions are relatively simple, there are loads of older schemes with weird and wonderful rules and simply determining what the death benefit is can take time.

3. Coordination between parties:

The process now involves potentially four parties - the PRs, the pension scheme administrators, the beneficiaries and HMRC. Coordinating accurate information between these four parties will be key. On a related point, new IT systems are required for pension providers to support tax withholding and reporting and interact with PRs and HMRC (and presumably HMRC has the same challenge) – are these ready?

4. Increased compliance burden on PRs:

PRs face greater reporting obligations and potential personal liability for errors or late payment, alongside the need to interpret complex pension and tax rules.

For most of our clients we would expect PRs to appoint lawyers to deal with the responsibility of sorting out the estate, liaising with Carbon as required. But of course this will come at a cost, and a greater cost than has been the case in the past due to the increased complexity.

If ever there were a reason to review and tidy up old pension arrangements, this is it! And of course you should review your pension death benefit nominations, your Will and ensure you are clear who your PRs are.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). As noted, the value of your investments (and any income from them) can go down as well as up, and this would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. Note that Carbon does not offer tax advice – if you require tax advice we can introduce you to suitable expert. Levels, bases and reliefs from taxation may be subject to change.

If you would like to discuss any of this with a financial planner, please contact 0131 220 0000 or email enquiries@carbonfinancial.co.uk