By the time the Budget eventually arrived on 30th October, the media had predicted just about every pension tax change you could possibly imagine.
So to that end, I suppose they were right with one of their “expert predictions” that pensions are to form part of the Inheritance Tax (IHT) estate.
In my latest essay, I will look at this announcement in more detail.
What has changed
Pensions have always been within the scope of IHT. However there has historically been an IHT exemption where the pension scheme has the discretion over who will receive the pension fund upon death of the member. With this arrangement, typically, the member nominates where they would like the funds to be paid and usually the scheme follows this direction, but ultimately it is still for the scheme to decide.
This exemption will no longer apply from April 2027, and bar a few exceptions such as leaving the pension fund to charity, all remaining pension funds on death will be added into the rest of the estate for the purposes of IHT.
What impact will this have?
This change will have varying levels of consequences for individuals, depending on their own situation. Let’s look at an example:
Stephen is single with no children and is age 72. He has a home worth £600,000 and other savings and investments totalling £400,000. In addition, he has a pension fund currently valued at £400,000.
The position for Stephen is as follows:
| Current Position | After 5th April 2027 |
Property | £600,000 | £600,000 |
Savings and Investments | £400,000 | £400,000 |
Pension | Not applicable | £400,000 |
Total estate for IHT | £1,000,000 | £1,400,000 |
Less Nil Rate Band of £325,000 | £675,000 | £1,075,000 |
IHT Liability | £270,000 | £430,000 |
This represents a substantial increase in the total IHT liability.
After deduction of IHT, the remaining fund may also be subject to an income tax charge on the beneficiary, depending on the circumstances.
How will the new rules work?
At the moment we have probably more questions than answers. A consultation period has commenced concerning the process, which is due to run until January 2025. Hopefully we will have greater clarity after that time. For now, we believe the broad process will be as follows:
The deceased’s personal representatives will notify the pension provider of the death.
The pension provider will confirm to the personal representatives the value of the pension fund.
The personal representatives, using a new calculator to be made available by HMRC, will calculate how much of the Nil Rate Band is available for the pension scheme.
The pension scheme will settle the IHT due from the scheme, as a proportion of the overall IHT due.
The pension death claim may then be settled.
We think there are a lot of wrinkles to be ironed out here, and we can foresee a lot of potential difficulties. So we’ll be keeping a close eye on the outcome of the consultation for further clarification.
Are there any other consequences?
Yes there will be consequences that perhaps weren’t intended but which will be nevertheless very lucrative for the Treasury. For example:
Due to the existing income tax that applies to beneficiaries who inherit pensions from someone over the age of 75, the effective rate of tax applicable to a pension fund could be as much as 67%. This means, of a £100,000 fund, the ultimate beneficiary could be left with just £33,000.
At the risk of sounding like a sensationalist newspaper headline, there could be scenarios where there is an effective IHT rate of almost 90%. Therefore careful analysis and planning for individual circumstances will be crucial.
No doubt many other scenarios will come to light in practice.
Is there any good news?
Yes, there is. Where a couple are married, upon first death the surviving spouse will benefit from the spousal IHT exemption. This essentially means the surviving spouse won’t notice any change from the current position.
For unmarried couples the spousal exemption would not apply. Therefore, any unmarried partners should consider the impact of any IHT due upon first death. This part is not good news, but mentioned for completeness.
What can we do about it?
We still have two and a half years before this change comes into effect. Until we have further clarity, we feel in most cases the best thing to do is watch and wait. However, planners as we are by nature, we have been thinking hard and already have a number of potential strategies that could go some way towards mitigating the impact of this change.
As is often the case though, what’s right for one will be wrong for another, therefore we will be carefully considering individual client scenarios and making personal recommendations accordingly, as appropriate. We expect this issue to feature regularly in our Forward Planning meetings with our clients over the next few years and beyond.
The one overriding change to our planning strategy is that we may actually begin to use pensions for their intended purpose again - to provide an income in retirement. Up until this change, bizarrely, pensions have been far more valuable as an inter-generational wealth transfer tool. Apart from simply needing the cash, I think this has been the government’s biggest motivations for bringing about this change.
Summary
I am surprised that there seems to have been relatively little coverage of this change to pensions tax, considering the potentially substantial increases in IHT liability that it will bring about. We envisage that many of our clients will be impacted, so this is an area we will be keeping a very close eye on.
As mentioned above though, we think in most cases it would be best to wait and see the outcome of the consultation before taking any action.
Best wishes,
Michael Roberts FPFS
Chartered Financial Planner and Director
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