Budget 2024: Inherited pensions move into the scope of IHT from 2027
One key point from the Budget which was glossed over by Rachel Reeves is that inherited pensions will be subject to inheritance tax from April 2027. To fully understand what this means, it is helpful to take a close look at current pension provisions before considering the proposed changes.
What happens to your pension when you die?
Discretionary pensions are written in trust and, provided you have let the trustees of your pension scheme know what you want to happen to your pension on your death, can be passed on to your loved ones outside of your estate and free of inheritance tax.
Some pensions such as the NHS, judicial schemes in the UK and many non-UK schemes are non-discretionary. These schemes are already treated as part of an individual's estate for inheritance tax purposes and inheritance tax is paid on them accordingly by the deceased's personal representatives (PRs). PRs can then seek reimbursement directly from the actual beneficiary of the pension funds/death benefits.
In recent years, discretionary pension schemes have been increasingly used and marketed as a tax planning tool to transfer wealth without that wealth being subject to inheritance tax. This has been encouraged by certain changes in pensions tax policy over the past decade, most recently the abolition of the Lifetime Allowance in March 2023 (which removed the cap on the amount of tax-relievable pension savings an individual can accumulate over their lifetime). Individuals can therefore accumulate unlimited tax-free savings in their pension whilst drawing on other means to fund their retirement, leaving their unused pension assets to be inherited by beneficiaries free of inheritance tax.
However, the beneficiary of a discretionary pension passed on from a family member who has died over the age of 75 is subject to income tax on any benefits taken.
What will happen after 6 April 2027?
From 6 April 2027 most unused pension funds and death benefits in both discretionary and non-discretionary schemes will be included within the value of a person’s estate for Inheritance Tax purposes. According to HMRC, Pension scheme administrators will become liable for reporting and paying any Inheritance Tax due on pensions to HMRC (which I bet they're thrilled about), with the government predicting that it will affect around 8% of estates each year.
This raises a painful scenario: If an individual dies after the age of 75 years, the pension passed on to the beneficiary will now seemingly be taxed twice, firstly for inheritance tax and secondly for income tax when any benefits are taken.
The exact details and procedures of inherited pension are not yet in place. The government has launched a technical consultation regarding liability, reporting and payment. If you're interested, be sure to provide HMRC with your thoughts on this matter before 22 January 2025 Inheritance Tax on pensions: liability, reporting and payment - GOV.UK