In July the Government published draft legislation and other documentation related to its plan to bring unused pension funds and pension scheme death benefits within scope of inheritance tax (IHT) from 6 April 2027.  A key change from the original proposals is that it will be the deceased’s personal representatives (PRs), not scheme administrators, who will have prime responsibility for paying IHT on pension funds.  However, the draft legislation makes provision for scheme beneficiaries to require scheme administrators to make IHT payments in some circumstances.

Death benefits that won’t be subject to IHT

Dependants’ scheme pensions (ie survivor pensions paid from a defined benefit pension scheme) will not be subject to IHT.  In the case of joint life annuities (ie where an annuity is purchased for a member on terms that an annuity will be paid to the member’s spouse or other dependant following the member’s death) the Government has confirmed that the rights of the survivor are not part of the member’s estate and therefore not in scope of IHT.

A benefit payable to a deceased member’s spouse or civil partner will not give rise to an IHT charge (even if the benefit would have been subject to IHT if paid to someone else).

A lump sum death in service benefit payable on the death of an active member “in employment of a description specified in the terms of the scheme” will not be subject to IHT.  There seems to be a possible mismatch here between the Government’s intention and the wording of the draft legislation.  From the accompanying document, it does not appear that the Government intends to impose IHT in respect of lump sum death in service benefits payable from registered life assurance schemes.  However, a person only satisfies the statutory definition of active member if there are arrangements for the accrual of benefits to or in respect of that person.  Members who have life cover only and are not earning pension benefits are not normally considered to have “accrual” of benefits.

Death benefits that will be subject to IHT

The basic principle under the draft legislation (subject to the exceptions outlined above) is that funds that must or may be used to pay a death benefit are treated as forming part of the member’s estate.  This means that if a lump sum benefit is payable which is not an exempt death-in-service benefit, that lump sum will in principle form part of the member’s estate for IHT purposes.  Lump sums that could be caught under this rule include lump sums payable under 5 year guarantees (ie where a member dies less than 5 years after starting to receive a pension) and an unused pension pot under a money purchase scheme where the deceased member was not an active member at the date of death.  If the relevant lump sum is paid to the member’s spouse or civil partner, it will still benefit from the spouse or civil partner exemption and no IHT charge will arise.  However, if it is paid to someone else, an IHT charge will arise if the member’s estate is large enough to exceed the nil rate band.  So an IHT charge could arise where, for example, a lump sum from an unused pension pot is paid to a deceased member’s child or unmarried partner.

The draft legislation also includes changes to the law on pension funds in drawdown.  The law allows a pension fund in drawdown to be nominated for the benefit of another person following a member or beneficiary’s death.  There is no requirement to actually draw a pension from the fund and no limit to how many times a fund can be nominated for the benefit of someone else following a beneficiary’s death.  However, once the changes take effect, a beneficiary’s omission to draw down funds could amount to a “deemed disposition” for IHT purposes, meaning that the undrawn funds are treated as forming part of a deceased beneficiary’s estate. 

Responsibility for paying IHT

In a key change from the original proposals it will be the deceased’s PRs rather than the scheme administrator who will have prime responsibility for paying IHT in respect of pension schemes.  To calculate the liability, PRs will need to obtain information regarding all the deceased’s pension schemes.  Scheme administrators will have new responsibilities to share information about death benefits with the deceased member’s PRs.  For this purpose the “scheme administrator” has the specific meaning set out in the Finance Act 2004 (FA04), meaning that the scheme administrator for this purpose will often in practice by the scheme trustees rather than the person who carries out day to day administration of the scheme.  Scheme administrators will have new responsibilities to communicate the potential tax consequences of decisions to members and their beneficiaries.

The draft legislation introduces a new “scheme pays” arrangement under which a scheme beneficiary with an IHT liability of £4000 or more may give notice to the scheme administrators requiring them to pay the tax.  Scheme administrators will have discretion to make the tax payment if they receive the requisite notice from the beneficiary, but the amount involved is less than £4000.

Our thoughts

The fact that the prime responsibility for meeting death benefit-related IHT liabilities will fall on the deceased’s PRs and not the scheme administrators is welcome news for scheme trustees.  However, the introduction of new information sharing requirements and “scheme pays” arrangements and the need to update member literature regarding the tax position in relation to pension scheme death benefits will mean that the changes will generate a significant amount of compliance work for pension scheme trustees.