Practical guide: Inheritance tax on pensions

All change

HMRC has published a technical note which explains in some detail how the inheritance tax (IHT) on pension fund provisions will operate in practice. Draft regulations have been published for comment and further guidance and supporting materials are to be published before the April 2027 start date.

The new rules do not apply where a person dies before 6 April 2027, even if their pension benefits are paid to their beneficiaries after this date.

Most registered pension schemes operate on a discretionary basis. This means that the trustees decide who receives the benefits, taking into account expressions of wishes made by the scheme member. For IHT purposes, the notional pension property is treated as being vested in the beneficiary when the trustees make their decision and the beneficiary becomes entitled to the pension benefits. Where the scheme is a non-discretionary scheme, the pension benefits are treated as being vested in the beneficiaries once they have been identified in accordance with the scheme rules.

Where an IHT liability arises on unused pension benefits, the personal representatives (PRs) will be responsible for reporting the liability and paying any IHT that is due. Once the notional pension property is vested in a beneficiary, the beneficiary becomes jointly and severally liable with the personal representatives for the IHT due on that property. In certain circumstances the pension scheme administrator may pay the tax.

Payment due date

Where an estate includes pension benefits, IHT on notional pension property will be due at the normal IHT due date which is the end of the sixth month after that in which the deceased died. Interest runs from the due date if the IHT is paid late.

Valuing notional pension property

The new rules are set out in s.150A Inheritance Tax Act 1984 , and treat a member as being beneficially entitled to the notional pension property held within a registered pension scheme, a qualifying non-UK scheme or an occupational scheme set up under an irrevocable trust. The new legislation sets out how a member’s notional property is valued.

For each money purchase scheme, the taxable amount is the sum of:

• the value, immediately before death, of any property that is held in the pension pot and may or must be used to provide benefits under the arrangement on the death of a member; and
• the value, immediately before death, of any property that is both not held in a pension pot and may be and can reasonably expected to be used to provide benefits under the arrangement on the death of the member.

Where it is a defined benefit arrangement, you should add together the amount of any benefit:

• that must be paid as a lump sum under the scheme
• not within the first bullet which may be and can reasonably be expected to be paid as a lump sum death benefit under the arrangement on the death of the member; and
• that may be and, assuming the maximum amount payable possible is paid as a lump sum benefit, can reasonably expected to be paid as a scheme continuation benefit under the arrangement on the death of the member.

In each case, the pension scheme administrators should deduct excluded benefits. These include:

• an authorised death benefit paid to a dependant after a member’s death (which includes a surviving spouse or civil partner and children (and others where the scheme rules permit) who were financially dependant on the member (known as a dependants’ scheme pension)
• a trivial commutation lump sum death benefit where it extinguishes a beneficiary’s entitlement to a dependants’ scheme pension
• joint life annuities; and
• death in service benefits.

For collective money purchase schemes, the pension scheme administrator must follow the calculation that is appropriate for each arrangement of which the member is a part.

Payments to exempt beneficiaries, such as transfers between surviving spouses and civil partners where both are long-term UK residents, are not taken into account in calculating the notional value of the pension property.

Information sharing

Pension scheme administrators are already required to share information about the deceased to the beneficiaries after a scheme member dies. Further legislation is to be introduced in light of the new rules.

The personal representatives (PRs) will need to contact all of the deceased’s pension schemes to request the value of the notional pension property and how this is split between exempt and non-exempt beneficiaries. The pension scheme administrator should provide this within 28 days of receiving the request (or an estimate where the final value cannot be provided in this timeframe, with a final value provided within 14 days of obtaining the valuation).

The PRs may later request details of the beneficiaries (full name, address and NI number (if known)). The pension scheme administrator must also provide details of the notional pension property payable to each beneficiary to enable their IHT to be calculated and details of the tax-free lump sum benefit paid, and any IHT paid by the scheme directly to HMRC. If the allowance has been exceeded, HMRC must be notified.

Withholding

Most estates that include notional pension property will not have an IHT liability. Where an estate does, the PRs can instruct the registered pension scheme to withhold 50% of the beneficiary’s entitlement under the scheme. The notice can be issued between the date of death and the end of the 15^th month after the deceased died. It can be lifted by the PRs when the IHT on the estate has been paid.

If the pension scheme administrator ignores a withholding or payment notice, they become jointly and severally liable for the IHT on the notional pension property with the PR and the beneficiaries.

A payment notice may be issued by the PRs and pension beneficiaries which requires the pension scheme administer to pay the IHT due on the notional pension property direct to HMRC.

Interaction with income tax

The new IHT rules apply in addition to the income tax rules. The income tax implications depend on the age at which the deceased died. Where a person dies before the age of 75, income from the survivor’s benefits and dependants’ drawdown funds are usually tax free, as are lump sum death benefits. However, where the deceased was over 75 when they died, all death benefits are taxable.

Dependants’ scheme pensions are always taxed at their marginal rate but are excluded benefits for IHT purposes.

Where IHT is paid in relation to death benefits, the portion of the benefits corresponding to the IHT and interest paid does not count towards the beneficiary’s taxable income. The legislation also sets out how to calculate the adjusted amount of the tax-free lump death benefit when IHT is due, and multiple sums need to be tested against the member’s lump sum and death benefit allowance. Where a lump death benefit charge arises when a taxable lump sum benefit is paid to a non-qualifying person, relief will be available for the IHT paid.