From 6 April 2027, the inheritance tax regime in England and Wales will undergo a significant change in the way pensions are treated on death.
For many years, pensions have been viewed as an efficient vehicle for passing wealth between generations, often falling outside the scope of inheritance tax. The new rules effective from 6 April 2027 will alter that position and are likely to have a material impact on estate planning for many individuals and their families.
Bringing pensions within the inheritance tax framework
The reforms introduce a new concept of “notional pension property”, which is broadly the value held within a pension arrangement immediately before a person’s death. The value of the notional pension property will be treated as part of the deceased’s estate for inheritance tax purposes.
When does inheritance tax arise on pension benefits?
The timing of the inheritance tax charge after a person’s death is closely tied to when a beneficiary becomes entitled to benefits arising from the notional pension property.
Where a pension scheme operates on a discretionary basis, which is the most common arrangement, no individual following a death has an entitlement to any pension benefits until the trustees have decided who should receive the benefits. Once the trustees have decided, the value of those benefits is treated as having “vested” in the beneficiary, and this is when the inheritance tax position crystallises.
Where a pension scheme operates on a non-discretionary basis, the position is more straightforward, in that the value is treated as vested when the beneficiary is identified in accordance with the pension scheme rules.
This distinction between discretionary and non-discretionary schemes will be important in practice, as it affects both the timing of the inheritance tax liability arising and also the obligations that follow it.
Who is responsible for the inheritance tax?
The new regime introduces a shared responsibility for inheritance tax which is more complex than under the existing rules.
Personal representatives will be responsible for reporting pension values as part of the deceased’s estate and for paying any inheritance tax due. However, once pension benefits have “vested”, the beneficiaries who are entitled will also become jointly liable for the inheritance tax attributable to their share.
In addition, pension scheme administrators may themselves become liable for the inheritance tax in certain circumstances, for example if they fail to comply with a valid instruction from the deceased’s personal representatives (most commonly the executors) relating to withholding or payment of the inheritance tax.
As a result, the new regime creates a system in which multiple parties may become jointly responsible, requiring careful coordination between executors, beneficiaries and pension providers and the relevant trustees.
How will pension values be calculated?
The amount of the pension value brought into the inheritance tax calculation depends on the type of pension scheme.
For defined contribution schemes, the starting point is the value of the pension pot and any other assets that could reasonably be used to provide death benefits. For defined benefit schemes, , the calculation is more complex and may include lump sum death benefits, guaranteed annuity payments and other benefits that could reasonably be expected to arise on a person’s death.
The valuation of the pension benefits is based on open market value at the date of death, and pension scheme administrators will be required to provide that valuation (or an estimate where necessary) within 28 days of receiving a valuation request.
Where there are cash and investments in the deceased’s pension fund, this may be relatively straightforward. However, where there are assets such as agricultural land or commercial property within the pension, this will be much more difficult to achieve.
What benefits remain outside of the inheritance tax net?
While the reforms are wide-ranging, a number of important exclusions remain.
Certain benefits will not be subject to inheritance tax, including pensions paid to dependants, death-in-service benefits provided by an employer, and some types of annuity arrangements. In addition, the usual inheritance tax exemptions continue to apply. Therefore, transfers to a surviving spouse or civil partner remain entirely exempt, as do gifts to UK registered charities and certain other qualifying bodies.
These exclusions mean that, while the scope of inheritance tax is widened considerably, there are still opportunities to mitigate the tax exposure in appropriate cases.
What are the responsibilities for personal representatives?
A notable practical consequence of the new rules is the increase in the level of responsibilities placed on personal representatives.
Personal representatives will be expected to take active steps to identify all pension schemes held by the deceased at the date of their death. This is likely to require the personal representatives to review financial records, contacting pension providers and liaising with advisers. They must then obtain valuations, include those figures in the inheritance tax account, and make any necessary corrections if additional pension assets are later discovered.
These reporting obligations go beyond what many personal representatives have previously encountered and are likely to increase both the administrative burden and also the time required to complete the estate administration which will be frustrating for many families.
What are the mechanisms for paying the inheritance tax?
Recognising that pension benefits may not yet have been distributed when inheritance tax becomes due, the legislation introduces new mechanisms to facilitate payment.
Personal representatives can issue and serve on the pension scheme provider a “withholding notice”, enabling a portion of a beneficiary’s pension entitlement to be retained within the pension scheme pending resolution of the inheritance tax position.
In addition, a direct payment mechanism allows pension scheme administrators to pay inheritance tax directly to HMRC from the pension funds on the personal representatives providing the relevant authority to do so.
What is the interaction of these changes with income tax?
The income tax treatment of pension death benefits remains broadly unchanged.
Benefits may still be tax-free where death occurs before age 75, and subject to income tax where death occurs after that age. However, a key safeguard is included to prevent double taxation.
Where inheritance tax is paid on pension benefits, the corresponding amount is not treated as taxable income for the beneficiary. This ensures that beneficiaries are not taxed twice on the same value, although the overall tax burden may still be significantly increased.
What are the ongoing obligations and potential complications?
The new regime does not end once the initial inheritance tax return has been submitted. If further pension assets are identified at a later stage, personal representatives must notify HMRC and amend the inheritance tax position accordingly. Beneficiaries may also become liable for additional tax in relation to their share, and any repayment claims must generally be made directly to HMRC.
Where additional pension funds are identified later on, this may cause complications for a beneficiary’s personal income tax position which may lead to separate reporting to HMRC. There is yet to be any guidance as to how these complications will be overcome, simply stating that more guidance on this point will follow.
Looking ahead
The inclusion of pensions within the inheritance tax framework represents one of the most significant developments in estate planning in recent years.
For individuals with substantial pension savings, the impact for their families after they have gone could be considerable, both in terms of inheritance tax exposure and administrative complexity.
While the changes do not take effect until 6 April 2027, it is prudent for people to begin reviewing their existing Will and estate arrangements now. Understanding how pension wealth fits within the overall estate, and how it will be taxed on death, will be an increasingly important part of effective planning moving forward.
Undoubtedly, obtaining expert professional advice will be key in helping people navigate these changes with confidence to ensure that estate plans remain aligned with both personal objectives and also the evolving tax landscape. For any advice or guidance, please contact our team here.
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