Techzone

There had been plenty of speculation ahead of the budget that the chancellor might seek to bring pensions within the IHT net. It was therefore no great surprise when she announced that unused pensions and death benefits would be included in the estate from April 2027. However, the extent of the proposed changes and the way they will be implemented has raised one or two eyebrows.

What will be caught

Much of the speculation surrounded DC pension pots. An IHT charge to counteract 2015's Pension Freedoms seemed a likely bet. The Budget announcement went much further.

Where a client dies after 6 April 2027 most death benefits will be included within their estate for IHT. The consultation paper confirms this will apply to –

• All residual DC funds, whether in drawdown or uncrystallised
• DB lump sum death benefits
• Annuities – where there are survivors' death benefits
• Lump sums from pensions in payment with value protection
• Trivial commutation lump sum death benefits

The above benefits will be included with the estate regardless of whether the scheme administrators/trustees have discretion over the payment of death benefits or not.

What is out of scope

It's worth remembering that, while unused pension funds will be subject to IHT, where benefits are paid to a spouse or civil partner these will be covered by the spousal exemption. This will be the case even where scheme administrators/trustees exercise their discretion in favour of the spouse.

Dependants' scheme pensions from DB schemes will not be subject to IHT. Neither will charity lump sum death benefits, provided payment is made to a qualifying charity.

Excepted group life schemes and other life policies provided by an employer as part of a pension package would also appear to be excluded.

Taxing pension death benefits

It will be down to the pension scheme to deduct and pay any IHT which may be due on pension death benefits. But before this can be done, the scheme administrator will need to know how much of the deceased's available IHT nil rate band is to be deducted.

The value of the pension death benefits paid to a non-spouse or civil partner will be aggregated with the other assets in the deceased's estate. The nil rate band will be apportioned in line with the respective values of the estate and pension death benefits.

What impact might this have on payment of death benefits?

Obtaining the necessary information to apportion the nil rate band may well lead to delays in obtaining probate and distributing both the estate and any pension death benefits. Any IHT due, by both the estate and any pension schemes, must be paid within 6 months from the end of the month in which death occurred to avoid late payments fees and interest.

The scheme administrator will have two months from being notified of the death to provide a valuation to the executors. Once the executors have received valuations from all the deceased's pension schemes, along with all the deceased's other assets, they will need to tell each pension scheme how much nil rate band is available to be deducted.

Clearly there will be a strong argument for consolidating pension schemes for those with multiple pension pots to avoid repeated information requests and reduce the risk of delaying the distribution of the estate.

How will the IHT charge interact with other pension tax charges

Where death occurs after age 75, both IHT and income tax may be payable. The IHT charge would first be deducted by the scheme administrator, with any benefit paid to a beneficiary then taxed at their marginal rates. That could give a worst case scenario of an effective rate of 67% if the whole amount was subject to IHT and then additional rate income tax on the balance.

This reduces to an effective rate of 52% where income is taxable at basic rate. This is actually less than the previous 55% tax payable on lump sums that applied before the introduction of pension freedoms in 2015.

Where a lump sum is payable to a bypass trust post 75, this could be subject to both IHT and the 45% special lump sum death benefit charge, resulting in an effective rate of up to 67%. This means the trustees of bypass trust will have just £33,000 to invest from a £100,000 death benefit which was fully taxable to IHT.

While the 45% death benefit charge of £27,000 may be available as a tax credit when the bypass trustees distribute to the beneficiaries, there will be no credit for the IHT deducted.

Where death occurs before age 75, pension funds may be subject to IHT but typically there will be no income tax to pay unless any lump sum death benefits paid exceeds the deceased's LSDBA.

What are the next steps?

The Autumn Budget announcement was accompanied by the launch of a technical consultation. The consultation is only seeking views on the implementation and processes required to bring pension within the scope of IHT. So, it's fairly safe to say that this will go ahead largely as intimated.

However, the draft legislation required to bring pensions within the estate could still be some time off, which makes certain aspects of planning difficult.

Currently, pension death benefits are generally outside the scope of IHT. Fresh clauses will need to be inserted to include unused pension funds within the estate for IHT to apply. How this is defined within the IHT act may have implications for other reliefs and exemptions such as tapering of the Residence Nil Rate Band and Business Relief.