Techzone

The introduction of IHT on pensions presents many challenges. But one that is potentially being overlooked is the impact that the accumulation of lots of small pension pots can have on settling the IHT bill and ultimately delaying distribution of the entire estate.

It is the deceased’s legal personal representatives (LPRs) who are responsible for submitting the estate’s IHT return and paying any IHT due. This must be done before the deceased’s assets can be distributed to the beneficiaries.

The death benefit process

From April 2027, this will include IHT on any unused pension funds that the deceased held, even though the LPRs are not responsible for collecting and distributing those pension assets. That task remains with the Pension Scheme Administrator (PSA).

The process for this, as outlined in HMRCs consultation response, is that the LPRs will need to request valuations from PSAs for any pensions the deceased held at their death. The PSA must provide a valuation within 30 days of that request. Obviously, the more pensions an individual holds the more admin the LPRs have to deal with. But that is only the start of the issue.

In addition to scheme valuations, the LPRs will also need to know if any of the pension death benefits are to be paid to an exempt beneficiary, such as a spouse, civil partner or charity. Without this information, the IHT liability for each of a client’s pension pots and their free estate cannot be calculated.

Determining who will benefit

HMRC are unable to dictate how long a scheme takes to exercise its discretion over who death benefits are to be paid to. The PSA has a fiduciary duty to ensure that it has identified all the possible beneficiaries and fairly considered their interests and the wishes of the deceased scheme member. Only after they have undertaken this due diligence can they make their decision on who is to benefit. This may, and often will, take far longer than the 30 days in which they must provide the valuation.

Pensions which don’t have a death benefit nomination, or where the nomination was completed many years ago and where family dynamics may have changed, can slow down the decision-making process.

Advisers can help by reviewing death benefit nominations as part of annual client reviews. Whilst this isn’t binding upon the PSA, it does help demonstrate that the member’s latest wishes are considered.

The upshot of this is that the time taken to obtain probate will typically be determined by the speed of the last pension scheme to exercise its discretion. Until all schemes have determined who is to benefit, it's not possible to know the IHT liability and how this will be apportioned between each of the pension schemes and the remaining estate. This creates a scenario where a small pension pot which is a relatively insignificant part of the wider estate may hold up everything.

The cost of delay

Generally, the IHT bill must be paid within six months from end of the month in which the member died. Failure to do so will usually lead to penalties and interest being applied. HMRC currently charge 8% interest on late payments of IHT, which can mount very quickly for large estates.

For example, a client dies with a taxable estate of £1.5M. After deduction of the NRB and RNRB, the estate has an IHT liability of £400,000 (£1M x 40%). This includes a pension pot of £40,000 where the PSA hasn’t yet determined who is to benefit. For every month that IHT remains unpaid beyond the six-month deadline, the LPRs will be charged £2,667 in interest.

The benefits of consolidation

The risk of a pension preventing the distribution of the estate and running up late payment penalties can be reduced by consolidating them into a single scheme. Fewer schemes not only mean less admin for the LPRs, but also less chance of delay.

The benefits of consolidating pensions are well known and can include an opportunity to bring all pension assets under advice, improved benefit and investment options and lower charges.

Settling the IHT bill

The options for settling the IHT liability on unused pensions has introduced a further benefit to consolidation.

Broadly, the IHT on pension death benefits can either be paid by the LPRs or by the beneficiary. If the IHT is paid from the free estate, this can potentially result in the LPRs having to reclaim tax from the beneficiary. Also, the beneficiary may need to submit an income tax reclaim if they have had to pay income tax on taking money from the pension to pay their share of the IHT.

Alternatively, in some cases the IHT liability can be settled by the PSA using the new direct pay service. This may be preferable to either LPRs or beneficiaries having to find the money to pay the IHT liability in respect of that scheme. However, the PSA is only obliged to offer this if the IHT payable in respect of that pension scheme is greater than £4,000. Consolidating lots of pension into one larger pot generally means that the direct pay service will be available across all of a client’s pension savings, leaving no small pots with a liability below £4,000.

Summary

Many clients have accumulated pensions across different employers and providers. Left unchecked, these fragmented pots can lead to unnecessary complexity both in retirement and on death. Consolidation isn’t just about tidying up - it could help to ensure a smooth transfer of wealth across the client’s entire estate.

Advisers who actively engage with pension beneficiaries and their families can unlock a valuable opportunity to build relationships with the next generation. This approach not only helps retain assets under management but also creates a pipeline of future clients, strengthening long-term business sustainability.