UK inheritance tax changes could prompt members to rethink pension plans

Pension experts Rebecca Howard and Simon Laight of Pinsent Masons were commenting following the government’s response to a consultation on bringing most unused pension funds and death benefits within the value of a person’s estate for inheritance tax purposes from 6 April 2027.

The proposals, which were announced as part of last year’s Autumn Budget, were outlined in a technical consultation on the processes required to implement such changes, which ran from 30 October 2024 to 22 January 2025.

Currently, death benefits paid on a discretionary basis are not subject to inheritance tax. The government says the new measures will remove “distortions” that have resulted in pensions schemes in the UK being exploited as a “tax planning vehicle to transfer wealth, rather than for funding retirement”, and will iron out inconsistences in the way inheritance tax has historically been applied to different types of pensions.

In a welcome change to its original proposals, the government’s response indicates that death in service lump sums, including non-discretionary ones, will be excluded from inheritance tax.

Trivial commutation lump sum death benefits paid in respect of a dependant’s scheme pension, as well as joint life annuities paid to a survivor, are also now out of scope.

It was originally proposed that pension scheme administrators (PSAs) would be responsible for paying inheritance tax due in respect of death benefits paid from their scheme. However, the government says members’ PRs will now have primary responsibility for paying this tax. Beneficiaries will be jointly and severally liable for the tax once PRs have been appointed and there will be a mechanism by which they can request, and in certain circumstances, require the PSA to pay the tax on their behalf.

Commenting on the government’s response, Howard said: “The government has listened and made a number of changes to the original proposals that will be welcomed by the pensions industry. The exclusion of death in service lump sums, trivial commutation lump sum death benefits and joint life annuities is particularly welcome, although the measures continue to go beyond the stated policy intent of stopping pension schemes from being used as tax avoidance vehicles.”

Howard said that allocating responsibility for paying inheritance tax to PRs and beneficiaries was prudent “as the PRs will have an overview of the member's whole estate”. However, she cautioned that PRs could now face considerable additional administrative burdens, particularly those who are required to deal with multiple pension schemes.

The window for paying inheritance tax – within six months of the end of the month in which the member dies – remains unchanged, and this will also put additional pressure on trustees to make discretionary decisions quickly to avoid beneficiaries incurring substantial interest charges.

HM Revenue and Customs (HMRC) says that PRs can pay inheritance tax from the free estate even if beneficiaries have not yet been appointed, but there are concerns that this will only be a viable option if there is sufficient money available in the free estate. HMRC says it will mitigate this impact of the new measures by providing PRs, PSAs and beneficiaries with clear guidance, a calculator to advise whether inheritance tax is due, and a straightforward system to pay the tax liability.

“Where the PRs are lay individuals, it is to be hoped that HMRC will be able to provide the support they'll need to navigate these complex challenges,” said Howard.

Laight said the government’s decision to give PRs primary responsibility for reporting and paying inheritance tax could also have some unintended consequences. “This may provide an impetus to remove the exercise of discretion when paying certain types of lump sum, particularly in the personal pensions market,” he said. “However, the costs of making such a change would not be insignificant, given the need to rewrite legal documents and communicate with members. It could also lead to unpalatable outcomes if members fail to keep their binding nominations up to date.”

Illiquid assets are also recognised as an issue in the government’s response, although HMRC cites several possible options for PRs and beneficiaries to explore in such a scenario. This will raise difficult investment considerations for trustees and providers of certain types of schemes, particular self-administered pension schemes (SASSs) and self-invested personal pensions (SIPPs), where higher concentrations of illiquid assets are more common.

A number of detailed information protocols will also be necessary. PRs will be required to notify PSAs of a member’s death, but there is no indication of any easements for a scenario in which no PR has been appointed, or where a PR is not appointed in a timely manner.

PSAs will then be required to inform the PR of the value of the member’s death benefits within four weeks of that notification. They should also tell the PR whether the funds will be distributed to exempt beneficiaries – generally a spouse or civil partner – or non-exempt beneficiaries when that information is available.

PRs will use that information to determine whether inheritance tax is payable and notify HMRC. If, in practice, this needs to happen before the beneficiaries are identified, this information will have to be updated afterwards if funds are then found to have been directed to exempt beneficiaries.

PSAs will also have to tell the beneficiaries that they may be liable for inheritance tax and provide information on the ways this can be paid.

Ultimately, the PSAs will have to disclose the identity of the beneficiaries, including name, address, date of birth and National Insurance number, to the PRs. It is unclear how this will interact with trustees' obligations under GDPR. It could also raise particularly difficult issues in cases of family breakdown, where disclosing such information could prove particularly sensitive.

As a result of the changes, the government estimates one-off costs to professional PRs and pension schemes could reach £60 million. Ongoing costs for both pension schemes and professional personal representatives are estimated around £5 million, although this will not be evenly distributed as only a subset of estates will be liable to an inheritance tax charge.

“The industry will be watching closely to see the impact of these measures on member behaviour and whether unintended consequences will occur,” said Laight. “Will new savings be directed out of pensions to other savings vehicles, particularly by the wealthy? Will annuities see a resurgence in preference to drawdown, if certainty of income is no longer trumped by the ability to pass on unused funds to family without inheritance tax? Will we see more retirees run out of money, having lost the tax incentive to minimise drawdown levels?”