Pensions and inheritance tax – government push forward with radical reform

The government has taken a major step towards the implementation of their proposed changes to inheritance tax announced in the 2024 autumn budget by publishing the draft Financial Bill Measures in respect of unspent pensions on Monday. The draft Bill evidences that whilst the government has taken onboard some feedback on the proposed changes, they are showing no signs of wavering on their pledge to bring private pensions within the scope of inheritance tax.

Most pensions are deemed not to form part of a deceased person’s Estate under the current rules as the payment of any lump sum or similar death benefit is at the discretion of the Trustees of the pension provider. The result is that most pensions are currently beyond the scope of inheritance tax. In October 2024, the newly elected Labour government announced its intention to amend this rule and to render unspent pension funds subject to inheritance tax.

The announcement sent shockwaves through the financial advice sector as for the past decade many financial advisers were rightly suggesting that clients keen on mitigating their exposure to inheritance tax increase their pension contributions considerably. It was immediately apparent following the 2024 autumn budget that a large number of Estates that would not be subject to an inheritance tax liability under the current rules would be hit with an inheritance tax bill under the proposed new rules. For many families, a significant portion of their accumulated wealth now faces being taxed at 40% on their death which would not have otherwise been the case.

To exacerbate matters, income tax may also apply to lump sum benefits paid out from a private pension following the death of the policyholder if they were at least 75 years old. Numerous commentators have suggested that a punitive effective tax rate of 67% may apply in such circumstances if the beneficiary is an additional rate taxpayer and the Estate exceeds the available nil rate band by at least the value of the pension. However, it appears from Section 6(3) of the draft Bill that legislators have considered this eventuality as this provision permits the amount of inheritance tax paid from the deceased’s Estate to the detriment of the beneficiary to be deducted from the amount of the inherited pension that is subject to income tax at the marginal rate of the beneficiary provided that certain non-onerous requirements are met. It therefore appears more accurate to state that an equally unpalatable effective tax rate of 49% is likely to apply in such circumstances. Evidently, it will be more important than ever to seek appropriate professional advice on the deductions and exemptions available.

Widespread criticism followed the announcement and some retained hope that the government would reverse the decision. A period of consultation commenced on 30 October 2024 allowing stakeholders to voice their concerns. On Monday however, the draft Bill was published, and whilst there are some notable concessions from the government’s initial plans, it is evident that the government intends to press ahead with bringing pensions within the scope of inheritance tax.

The majority of the draft Bill reflects that which was already understood to be the government’s intention. Pensions are to be brought within the scope of inheritance tax for deaths on or after 6 April 2027. Two significant changes however are that the responsibility for reporting the value of any pensions held by a deceased person and settling any resultant inheritance tax liability now falls on their personal representative or executor and that death in service payments will remain beyond the scope of inheritance tax.

Whilst the latter change is welcomed, the former presents a difficult obstacle to the obligation on grieving family members to ascertain the extent of their recently deceased relative’s Estate and settle any resultant inheritance tax liability by the end of the month six months after their date of death. Pension providers often enforce onerous requirements for the provision of relevant documents, which may render obtaining the necessary information timeously a difficult task. Strict requirements prior to engaging in meaningful correspondence, inconsistent response times and a looming deadline will combine to create a cruel obligation on grieving families.

The proposed changes will impact countless families. Whether you are concerned that the changes may create or exacerbate an exposure to inheritance tax or require the Estate of a loved one to be administered timeously, it is becoming more important than ever to seek the appropriate professional advice. Our STEP accredited solicitors specialise in succession planning and our team are experienced in engaging with pension providers and settling inheritance tax liabilities within the imposed deadline.

Should you require advice or have any queries in respect of the proposed changes to inheritance tax, please do get in touch. We would be pleased to assist.

This article does not constitute legal or other professional advice.