Pensions and Inheritance Tax: What do we know so far?

In Labour’s budget in October 2024, they announced that pensions were going to be included in a deceased’s estate for the purposes of calculating their inheritance tax (‘IHT’) liability from April 2027.  This presents a huge change as currently pensions which are left to direct descendants are exempt from inheritance tax and so, for the last decade or so, they have been a way of passing down wealth to family members without suffering IHT on the value of the pension.

Since the announcement last October, there has been ardent lobbying against these proposals and many rumours about how the change may operate in practice.  The Government have now published their draft rules and whilst some have provided clarity, there are still some questions to be answered.

What do the draft rules address?

1. The Government has confirmed that the responsibility for paying any IHT due will fall to the deceased’s executors rather than the pension scheme administrators. It is hoped that this will prevent delays in winding up estates.
2. The full amount of the pension used to provide the death benefits will be included in the estate for the IHT assessment regardless of the assets held within the pension. This means that investments which carry some form of IHT mitigation, such as business relief assets and AIM shares will not attract IHT mitigation within the pension.
3. Pension assets passing to a spouse or civil partner will still be free of IHT.

The draft rules also clarify the process for reporting any IHT on pensions and this is summarised as follows:

1. The pension scheme administration has four weeks from being notified of the death to provide the executors with a valuation for IHT. If the scheme administrations have some discretion over payment of death benefits they must confirm how much will be paid to the spouse or civil partner and how much is to be paid to other beneficiaries and so added to the estate value for IHT calculation.
2. Executors include these pension values in the estate and determine if IHT is payable on the estate.
3. If IHT is payable, the executors need to calculate how much IHT is due on each of the pensions and submit an account to HMRC. They then need to inform the pension beneficiaries and the pension scheme administrators of the amount due.
4. The non-exempt beneficiaries are jointly and severally liable with the executors for the IHT due on their share of the pension. The executors can pay the IHT liability in full from assets within the estate but if they do not do this, the pension beneficiary can request that the scheme administrators pays the IHT due directly to HMRC (the pension scheme is only obligated to do this if the amount to be paid is over £4,000) or they can take the benefits and pay the IHT themselves.  If the deceased was over age 75 at date of death, the beneficiary will also pay income tax on the amount withdrawn from the pension to pay the IHT due.  In order to address this, HMRC have confirmed that the amount chargeable to income tax will be reduced by the beneficiary’s IHT liability.

How we can help

These rules are draft only at the moment and may still change before they are enacted, however, it does give some indication as to how the new process may operate in practice.  Given this is going to be a new process for executors and scheme administrators alike when the rules do come into force in April 2027, it is going to be more important than ever to take advice on winding up an estate and thereafter how best to pay any IHT due and distribute the assets within the estate particularly if the estate includes large pension assets. You can contact Head of Financial Planning, Anna.Gratwick@andersonstrathernam.co.uk to discuss any of the issues raised in this article.

Anderson Strathern Asset Management Limited is authorised and regulated by the Financial Conduct Authority.

When investments or advice have particular tax features, these will depend on an individual’s personal circumstances and tax rules may change in the future. Please keep in mind that the value of investments can go down as well as up, so you may get back significantly less than originally invested.