Changes to IHT and pensions risks becoming ‘a bureaucratic nightmare’

The Budget decision to include pensions and pension death benefits within estates for Inheritance Tax (IHT) may create significant challenges for bereaved families, according to Steve Webb, a partner at consultancy firm LCP.

The proposed changes, introduced in a government consultation, outline an extensive process for including pension assets in IHT calculations.

This, says Webb, could lead to “a bureaucratic nightmare” for grieving families attempting to settle the financial affairs of their loved ones.

“Bereaved relatives already face huge challenges in winding up the financial affairs of a loved one, including delays in obtaining probate and the need to pay IHT bills before finances may become available,” says Webb

Though it is possible for banks and savings institutions to release funds from the deceased’s accounts to pay the tax bill, this option often falls short if the majority of the estate’s value lies in property.

The government’s consultation proposes a detailed set of steps that families must follow to account for pension assets within the deceased’s estate.

If pensions are included in the estate’s value, families will need to contact each pension scheme in which the deceased was a member and request key information, such as fund values and death benefit entitlements.

Each pension provider will then have to verify the deceased’s benefits, confirm the beneficiaries and provide information on how much of the lifetime Lump Sum Allowance the deceased had used.

Once this information has been collected, the family can then calculate the IHT owed using an HMRC online tool, apportioning the IHT tax-free nil-rate band across different estate assets, including pensions.

Inherited pensions will be subject to IHT from 2027

After calculating the potential IHT bill, the family will need to notify each pension scheme of its share. The pension schemes will then report these details to HMRC, which will issue an IHT bill for each scheme’s share of the tax.

Pension schemes will have up to six months from the date of death to make payments to HMRC, after which the net benefits will be distributed to beneficiaries.

Meanwhile, the family must also settle any remaining IHT balance on non-pension assets such as property.

This additional administrative burden, says Webb, “could turn into a bureaucratic nightmare for grieving families”, particularly given the complexity of pension benefits and the time required to coordinate between various schemes and HMRC.

Moreover, any death-in-service lump sum – a common benefit included in pensions – could be significantly reduced by an IHT rate of up to 40%, making it less valuable for beneficiaries.

According to government estimates, around 49,000 estates per year that include pensions will now be subject to inheritance tax.

This change affects 10,500 estates that would otherwise not have been liable for IHT and an additional 38,500 estates that were already subject to the tax but will face an extra bill under the new rules.

In addition, families of deceased individuals with multiple or complex pension arrangements may need to track down the value of each pension just to verify whether any IHT is due.

Webb concludes: “If this proposal is to go ahead, the Government will need to come up with a much more streamlined process than is currently proposed.”