Finance Bill containing inheritance tax changes published

In our previous Update we reported on the draft legislation in relation to the Government’s plan to bring unused pension funds and lump sum death benefits within scope of IHT from 6 April 2027.  The Finance Bill containing the relevant provisions has now been introduced into Parliament.

A first important point to note is that a general IHT exemption for benefits payable to a spouse or civil partner applies in the context of pension scheme death benefits.  So a death benefit paid to the deceased member’s spouse or civil partner will not normally give rise to an IHT liability regardless of what type of benefit it is.

IHT in relation to defined benefit arrangements

For defined benefit arrangements the Bill provides that lump sum death benefits will be treated as forming part of the member’s estate unless:

• the lump sum is paid only in respect of active members.  It seems that this is intended to exempt death in service benefits paid as a multiple of salary.  However, the drafting is not clear and technically the exemption will not apply if the benefit is payable in respect of any members not in pensionable service (eg those in a waiting period or those eligible for life assurance benefits only);
• the lump sum is a “trivial commutation lump sum death benefit” that extinguishes the recipient’s right to a dependants’ scheme pension.  

Dependants’ scheme pensions are not treated as forming part of a member’s estate.  However, if a scheme continues to pay the member’s pension to another person for a fixed period  following the member’s death, that will form part of the deceased’s estate.

In a defined benefit scheme benefits likely to be caught by the IHT changes are:

• a lump sum death benefit under a 5 year (or 10 year) guarantee; 
• a lump sum death benefit representing a member’s contributions (assuming this is payable in respect of deferred members as well as actives), and 
• money purchase benefits from AVC pots.  

IHT in relation to money purchase arrangements

For money purchase arrangements the Bill broadly provides that a member’s unused pension pot will be treated as forming part of the member’s estate unless the relevant funds can only be used to provide the following types of benefit:

• a dependants’ annuity or nominees’ annuity that was purchased together with a lifetime annuity payable to the member. In practice, these will often be purchased in the member’s own name and therefore would not form part of the pension scheme in any event;
• a “dependants’ scheme pension” as defined in the Finance Act 2004  or trivial commutation lump sum death benefit that extinguishes the recipient’s entitlement to such a pension.  This is unlikely to be relevant to a money purchase scheme but could arise in a hybrid scheme; and
• a benefit that is only payable on the death of an active member.  The same issue described above for defined benefit schemes applies to a death in service benefit under a money purchase scheme.

IHT in relation to Life Assurance Schemes

A lump sum death in service benefit is excluded from the IHT changes where it is only payable to “active members”. Technically this means that benefits payable under a registered life assurance scheme do not benefit from the exclusion and will become subject to IHT.  This is because the members are not “active members” as defined in pensions legislation..  This is not consistent with the Government’s stated policy.  The Government has repeatedly said that death in service benefits from registered pension schemes will not be in scope of IHT.  Registered life assurance schemes fall within the statutory definition of “registered pension scheme”, and there is no obvious policy reason for making a distinction in tax treatment between lump sum death in service benefits payable from a registered life assurance only scheme and those paid from a registered pension scheme that also provides pensions.  

Anecdotally we have heard that HMRC take the view that members of registered life assurance schemes providing death in service benefits are “active members” and therefore not affected by the IHT changes.  However, this interpretation is at odds with the definition of “active member” in the relevant legislation.  At present we recommend that employers with registered life assurance only schemes keep a watching brief on this issue. 

There is no change in relation to excepted group life schemes (EGLS). These are subject to IHT but in practice, as long as the trust does not have value on inception or at any 10-year anniversary then the IHT charge is nil.

New “withholding notice” provisions where IHT may be payable

In a change from the draft legislation, the Finance Bill contains new powers for the deceased’s personal representatives (PRs) to give a “withholding notice” requiring the scheme administrator to withhold 50% of benefits for up to 15 months. (This does not apply to benefits paid to the deceased’s spouse or civil partner).  There is also a power for the PRs or beneficiary to require the scheme administrator to pay the IHT directly where the amount due is at least £1000 (a change from the figure of £4000 in the previous draft legislation).  Scheme administrators who fail to comply with a notice can themselves become liable for the IHT.

Action required

With just over a year to go until the changes take effect, trustees should be preparing now.  Issues to consider are:

• whether scheme administrators have plans in place to deal with the changes, and whether existing scheme administration agreements cover the additional work involved in dealing with the administration involved in IHT issues such as dealing with withholding notices and requests for direct tax payments;
• whether changes are required to scheme trust deeds and rules; and
• what changes to member communications will be required now and in the future in relation to IHT changes.