From 6 April 2027, unused pensions will be included in calculations for inheritance tax (IHT). As well as introducing new complexities for people who planned to keep excess savings in their pension to pass on to loved ones, the new regime also creates extra challenges for those dealing with the estate after someone dies.
Personal representatives will now need to factor pensions into the IHT process alongside the estate’s other assets. That means more paperwork, more complexity and more responsibility at an already difficult time. We’ve highlighted five key pressure points personal representatives will face in the new IHT and pensions world.
1. Telling the scheme someone has died
The personal representative will be responsible for telling the pension scheme the person has died. This means first tracking down all the pension schemes the deceased was a member of. Whilst that sounds straightforward, in the world of automatic enrolment it’s easy to become a member of a pension scheme when joining a new employer but then lose track of the pension when leaving that job.
The pensions dashboard when launched, hopefully next year, should help reunite many people with their lost pensions. But personal representatives aren’t expected to be allowed to use the first version of the dashboard, meaning they may be reliant on paperwork to track down pensions.
Alternatively, they could use the government’s pension tracing service or those provided by platforms including AJ Bell. Consolidating your pensions, where appropriate, to reduce the number of pension pots will help your loved ones tasked with sifting through the paperwork.
Once they have identified the correct pension scheme(s), personal representatives will need to prove both their identity and their authority to act on the member’s behalf.
2. Valuing the pensions
Part of a personal representative’s role is valuing the estate, and that includes the pension too. The first job is to ask the pension scheme to give a valuation of the pension account – the ‘notional pension property’ – as at the date of death.
Pension schemes are allowed to give an estimate if it is difficult to get a valuation – for example if a commercial property is held by the pension. The pension scheme has 28 days to reply with this information.
3. Working out if any IHT is due
Once the personal representative knows the value of all the pension schemes, as well as the other assets in the estate, they can start to work out what, if any, IHT is due.
Some beneficiaries are exempt from IHT, which means they do not pay IHT on assets they inherit. For example, no IHT is due on anything left to a spouse, civil partner or charity, including the pension.
If you leave your unused pension to anyone other than a spouse, civil partner or charity, they are treated as a ‘non-exempt beneficiary’. In that case, any unused nil rate band can reduce the amount liable for IHT. Most people start off with a nil rate band of £325,000, and some may also have a residence nil rate band of £175,000 if they leave a home to a direct descendant. You also inherit any unused allowance from your spouse or civil partner if they die before you. Any unused nil rate bands are apportioned across the estate and each pension scheme.
The proportioned nil rate band is deducted from the pension value, and the remaining amount should be subject to 40% IHT. HMRC plans to revamp its calculator to help personal representatives do these calculations and work out what, if any, IHT is due.
4. Asking schemes to withhold pension money
If the personal representatives believe that IHT is due, they can ask the pension scheme to withhold some pension money.
Most pension schemes decide who will inherit any unused pensions and then pay that money to them. They may make this decision before the personal representative has worked out what IHT is due.
If the personal representatives are worried that it will be difficult to reclaim any IHT due on the pension money, they can ask the pension scheme to put a hold on up to 50% of a beneficiary’s funds. This means that 50% can be paid to the beneficiary as soon as the scheme has done its paperwork, but 50% will be held back to pay a possible IHT bill. Any funds being paid to a spouse, civil partner or charity will not be withheld.
5. Paying IHT
Once the personal representative has agreed with HMRC what IHT is due, they then need to make sure the bill is settled. The personal representative is liable for the payment of IHT.
There are three ways to pay any IHT due on a pension:
- The personal representative can pay the IHT due from the wider assets held in the estate;
- The beneficiary of the unused pension can pay the IHT from their own pocket; or
- Either the personal representative or the beneficiary may be able to ask the pension scheme to pay the IHT to HMRC before the unused pension funds are paid to the beneficiary. The pension scheme has 35 days to pay the tax due. If the 35 days elapse and the IHT is still outstanding, then the pension scheme and the personal representative are jointly liable for the IHT due.
Once the IHT has been paid, the pension scheme can release any money they were withholding.
Rachel Vahey: Head of Public Policy
Rachel is AJ Bell's Head of Public Policy. She helps financial advisers and planners understand the changing pensions and savings environment, as well as how new legislation and regulation affects them and their clients.
Rachel...
