New regulations set to levy inheritance tax on unspent pension funds starting in spring 2027 are being criticized by legal and financial experts as overly complicated and unfair to bereaved families.
These changes will require executors of wills to track down pension information from various providers, a task they warn could lead to delays, increased costs, and legal risks for those already navigating the loss of a loved one. The complexity is amplified by the need to gather this information before probate and to comply with evolving tax requirements.
Inheritance tax is currently levied at 40% on estates exceeding a certain threshold, generally £325,000 for single individuals or £650,000 for married couples. An additional residence nil rate band can raise the tax-free threshold for those passing on their home to direct descendants. These thresholds are frozen until 2031.
Professionals, including those from Step, a body for inheritance professionals, have noted that while the government has made some adjustments, further simplification is necessary. Executors, also known as personal representatives, could face tax liabilities for assets they do not directly control. This poses challenges for cash flow and recovery, particularly if beneficiaries are difficult to locate or uncooperative.
Step has proposed that inheritance tax on pensions be calculated and paid directly from the pension fund, rather than making personal representatives responsible for managing the tax for each beneficiary. This would involve extending an existing direct payment scheme to pensions, allowing funds to pay the tax directly to HMRC within the six-month period after death, thus avoiding the accrual of interest.
Rachel Vahey, head of public policy at AJ Bell, outlined key administrative challenges for personal representatives:
First, they must locate all pension schemes the deceased was a member of, which can be difficult due to automatic enrollment and job changes. Proof of identity and authority to act is then required.
Second, valuing the pensions as of the date of death is necessary. Pension schemes can provide estimates if immediate valuations are challenging, with a 28-day response window.
Third, determining if inheritance tax is due involves considering beneficiaries and any available nil rate bands. Unused allowances from a deceased spouse or civil partner can also be inherited.
Fourth, if personal representatives are concerned about reclaiming inheritance tax, they can request pension schemes to withhold up to 50% of a beneficiary's funds, with exceptions for payments to spouses, civil partners, or charities.
Finally, paying the inheritance tax can be done from the estate's assets, by the beneficiary directly, or by asking the pension scheme to pay HMRC before releasing funds. Pension schemes have 35 days to pay, after which both the scheme and the personal representative may be jointly liable if the tax remains outstanding.
An HMRC spokesperson stated that steps have already been taken to simplify the process and that further guidance and tools will be provided. They also noted that over 90% of estates will continue to pay no inheritance tax after the upcoming changes. The new rules will allow the withholding of up to 50% of pensions for up to 15 months after death, though the six-month inheritance tax deadline remains unchanged.