There were a number of announcements in Rachel Reeves' Budget, big and small, but the most significant change, at least for pensions, is the inclusion of most unused pension funds and death benefits in the value of a person’s estate for inheritance tax purposes.
HMRC has already launched a consultation in which it sets out how this might operate.
But its proposals for how IHT should be paid create a number of potential issues.
What we know
According to HMRC, the change will apply to UK-registered pension schemes and to qualifying non-UK pension schemes (QNUPS).
Benefits in the IHT scope include uncrystallised defined contribution pots, drawdown, dependants and beneficiary annuities, annuity protection lump sums, and lump sum death benefits paid from a defined benefit scheme.
A very select group of pension benefits will be outside the scope of IHT, including charity lump sum death benefits and dependants scheme pensions.
However, the normal IHT exemptions apply where benefits are paid to a spouse or civil partner.
The current income tax treatment of death benefits remains in place, so for deaths on or after age 75 there is also income tax payable when remaining pension funds are withdrawn.
HMRC suggests any IHT due in respect of the pension benefits will be deducted from the pension funds and it proposes schemes will have to meet the deadline of paying IHT within six months of the end of the month in which death occurred.
This leads to a number of practical issues that I am sure will be raised with HMRC during its consultation.
Potential issues
Often a scheme will not be notified of death immediately.
And there will be a need, once these rules are in place, for the personal representatives and the pension scheme administrator to work together to establish the IHT charge and the proportion of the charge the scheme must pay.
The pension scheme clearly won’t know the value of the other estate, previous lifetime gifts, and so on.
It may also affect timescales for a pension scheme paying benefits.
A scheme will need to decide the recipient in the normal discretionary manner, taking into account expression of wish etc, before IHT can be calculated, as payments to a spouse or civil partner have a direct bearing on that.
But given the suggestion is to pay IHT from the pension pot, the scheme will not be able to make payments to the chosen beneficiary until the IHT bill has been deducted and paid.
The example below shows how the calculation could work, and the proportioning of the nil-rate band between the pension and other assets.
However, it is a very simplified example and, in reality, would potentially be affected by other areas such as the residence nil-rate band, other lifetime gifts and so on.
As the new rules do not apply until April 2027, we all have time to consider the changes and the impact these may have on how people manage their retirement income.
And I am sure there will be some changes to the proposals as we move through consultation.
