Private Pensions Inherited by Beneficiaries Will No Longer Escape IHT

How the changes to private pensions could impact your legacy

For years, private pensions have offered a tax-efficient way to pass on wealth to loved ones. Currently, any money left in a private pension fund upon death is exempt from Inheritance Tax (IHT). However, this long-standing benefit is set to end. Following announcements by the Chancellor of the Exchequer, from April 2027, private pensions inherited by beneficiaries will no longer escape IHT.

The current proposals for the new rules indicate that most unused pension funds and death benefits will be included within the value of a person’s estate. The nil rate band will be shared pro-rata between the pension funds and the rest of the estate. Besides this already sizeable tax, there is also the potential for double taxation, posing a further financial blow for grieving families.

Understanding Double Taxation on Pension Funds

Double taxation arises when the deceased passes away after the age of 75. While inherited pensions would already face the 40% IHT (alongside any other part of the estate that exceeds the nil rate band), they can also be subjected to income tax. Beneficiaries withdrawing from the pension fund may need to pay income tax at their highest marginal rate on the amount they access, further reducing the value of their inheritance.

Lengthy and Stressful Probate Process

The administrative burden posed by this change cannot be overlooked. Currently, IHT must be settled before probate – a legal step necessary to administer the estate – can be granted. Complications arise when wealth is tied up in property or investments that cannot quickly be liquidated to meet IHT obligations. Although some banks and financial institutions allow direct payments to HMRC, this is of little comfort if other assets are inaccessible.

Under the proposed rules in consultation, the executor of an estate will need to liaise with all of the deceased’s pension providers to determine potential IHT liabilities. This involves gathering detailed information about the remaining pension benefits and the named beneficiaries, a process that could take weeks or even months. Unsurprisingly, these changes have been criticised as a potential ‘bureaucratic nightmare’ at an already sensitive time.

Future Challenges for Executors and Families

With the new system, executors may face an uphill struggle. They will bear the responsibility of ensuring all pension-related data is collated and accurately reported to HMRC. Failure to do so could lead to delays in settling the estate or, worse, additional penalties. This level of responsibility comes at a time when bereaved families are likely to be navigating emotional turmoil, making the process even more daunting.

Adding to the complexity is the fact that pension companies often have varying policies and procedures. Some may offer efficient support in providing the necessary documentation, while others may create further delays. For grieving families, this level of inconsistency adds another layer of frustration.

Looking Ahead – Consultation and Potential Adjustments

The consultation for these proposed changes ended on 22 January, with further details to be given later in the year. This opens the door to potential adjustments based on public and industry feedback.

For individuals concerned about the tax implications of their estate, now is the time to act. Reviewing your pension and estate planning strategy will be crucial to ensuring you minimise potential tax burdens for your loved ones.

Taking Action to Protect Your Wealth

The removal of IHT exemption on private pensions represents a major shift in estate planning. While the intention may be to increase tax revenue, the practicalities could leave bereaved families facing significant challenges.

It’s more important than ever to understand how these changes might affect you and the steps you can take to safeguard your financial legacy.