Applying UK inheritance tax to pensions ‘risks delays and higher costs’

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Pension advisers and wealth management chiefs have urged the Treasury to rethink plans for how to apply inheritance tax to pension funds, warning that current proposals could lead to severe delays and increased costs for the bereaved, even in cases where no inheritance tax is due. 

In her Budget last autumn, chancellor Rachel Reeves announced that pension funds would become part of inherited estates by April 2027, a move set to upset tax planning by wealthy people but raise £1.5bn a year for the Treasury by 2030. 

The government estimates its proposals will bring about 1.5 per cent more estates within the scope of death duties in 2027-28, on top of the 4 per cent that already exceed the £325,000 nil-rate band, which can rise to £500,00 where a property is passed on. 

But concerns have been raised by tax and pension professionals about potential harmful effects in consultations on the technical details of the government proposals that close on Wednesday.

The Society Of Pension Professionals, a trade association, warned the government’s plans “impose unrealistic and impractical timescales” while applying interest charges or penalties on pension scheme administrators for delays “over which they have little or no control”.

The chief executives of some of the UK’s largest wealth managers, including Interactive Investor, Quilter and AJ Bell, have also written to the chancellor over the “flawed and potentially damaging” proposals, calling on the government to “work with the pensions industry to agree a simpler method of achieving the policy aim”.

The letter, seen by the Financial Times, said: “The complexity of the proposed approach, namely bringing all pensions into estates for IHT, will lead to substantial delays paying money to beneficiaries on death and cause distress for bereaved families.”

Under the proposals, personal representatives of inherited pension funds would be responsible for identifying the funds and calculating how much if any IHT is owed, taking into account other assets in the estate. The pension scheme administrator would then be responsible for paying the inheritance tax before releasing the funds.

Experts say this could cause delays in payouts, including to those not liable for the tax. Under current rules, inherited pensions can be paid more quickly to beneficiaries and used to pay for probate costs, funeral charges and other urgent bills.  

“The (new) process is complicated and it will punish lower earners,” said Anna Rogers, senior partner at Arc Pensions Law. “Wealthy people don’t need the money quickly . . . it seems the harm will be disproportionately to those who aren’t wealthy and those who die young.”

Lawyers are also concerned that the six-month window between death and the deadline for payment of inheritance tax does not leave enough time for pension funds to be identified and the tax to be calculated, leaving individuals vulnerable to late payment charges. 

“Pension scheme rules allow two years to pay death benefits . . . there may be a need to sell assets to pay the tax, but there might be cases of people not being able to pay, for example if a property needs to be sold,” said Jeremy Harris, partner at Fieldfisher.   

The SPP has urged the government to either leave the calculation and payment of IHT to the pension’s personal representative and HM Revenue & Customs — or for the benefit to be taxed in full at 40 per cent and paid promptly by the scheme administrator in the minority of cases where a pension is subject to IHT. 

Steve Hitchiner, chair of the SPP, said issues relating to the reporting and payment of inheritance tax on pensions was “vitally important” and the current proposals “will result in numerous problems and challenges which could be largely avoided”.

Some death in service benefits, designed to provide financial security for someone’s dependants if they die unexpectedly young, could also face a large inheritance tax bill, in cases where they are set up as part of the registered pension scheme.

“It’s got the potential to be quite a mess . . . at some point there will be a backlash,” Harris said.

Kate Smith, head of public affairs at Aegon, added that there is a lack of clarity over what is in scope and that “nobody thinks [the proposals] will work”.

The Treasury said: “We continue to incentivise pensions savings for their intended purpose of funding retirement instead of them being openly used as a vehicle to transfer wealth.”