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The introduction of IHT on pension death benefits from April 2027 has moved a step closer with the publication of draft legislation. There were widespread concerns that the original proposals were complex and would ultimately result in delays in winding-up estates. To address this HMRC have shifted the burden of reporting and paying the IHT on pension death benefits from the scheme administrators to the personal representatives.

Valuing pension benefits for IHT purposes

The draft legislation also provides clarity on the value to be included within the estate. This will be the amount used to provide the death benefit and ignores any business relief. There had been a great deal of speculation that holding business assets such as an AIM portfolio could be a way of mitigating the IHT liability post 6 April 2027, but this has now been put to bed.

The New Process

HMRC have issued draft rules for bringing pension death benefits within the estate for IHT from April 2027. They have also outlined the process which personal representatives (PRs) and the pension schemes must follow. In a change to what was originally proposed at the autumn Budget it is now the PRs rather than the scheme administrator who is responsible for reporting and paying IHT on the death benefits.

Stage 1: Pension scheme to provide valuation to PRs

The scheme administrator will have 4 weeks from the notification of death to provide the PRs with a valuation for IHT purposes. This means that where the scheme has discretion it must confirm the split between how much of the death benefit is to be paid to a spouse or civil partner and therefore free of IHT, and how much is to be paid to non-exempt beneficiaries and potentially subject to IHT.

Stage 2: PRs value the estate

The PR will be required to collect the values of all the pension schemes the member held and aggregate these with all the other assets within the deceased's estate to determine if an IHT account is required.

Stage 3: PRs to submit IHT account

If IHT is due, the PRs must determine how much is attributable to each of the pensions within the estate and submit an account to HMRC. They must then inform the pension beneficiaries and the scheme of the amount of the IHT due on their component of the estate.

Stage 4: Payment of death benefits

Where the death benefits are free of IHT either because the total value of the estate is below the available nil rate band or it is to be paid to a spouse or civil partner the benefits can be paid immediately without the need for probate.

Non-exempt beneficiaries will be jointly and severely liable with the PRs for the IHT due on their share of the death benefits. If the PRs haven't settled the IHT due on the pension death benefits from the free estate the beneficiary will be given two options.

1. They can request that the scheme administrator pays the IHT due directly to HMRC on their behalf.
2. They can take benefits and pay the IHT due. This will of course result in income tax if the scheme member dies after age 75. HMRC have confirmed that the amount chargeable to income tax will be reduced by the beneficiary's IHT liability.

Alternatively, the PRs can pay the IHT bill in full from other assets within the estate. If the estate beneficiary and the pension beneficiary are the same person, the pension death benefits can be paid without any deductions from the pension. If they are not the same person, the PRs have a legal right to reclaim the IHT due on the pension death benefits from the pension beneficiary and distribute this to the estate beneficiaries. This is to ensure that the burden of IHT is spread fairly amongst all beneficiaries.

Specific points

The consultation response also provided additional clarity on several points.

Death in service

HMRC have confirmed that all death in services schemes regardless of how they are provided will not be subject to IHT. This ensures consistency between death in service benefits due from a registered scheme and those paid through an excepted group life arrangement.

Joint life annuities

Survivors benefits under a joint life annuity will not be subject to IHT. Where the continuing payments are made to a spouse these will be covered by the IHT spousal exemption. Where the payment continues to someone other than a spouse HMRC have confirmed that the survivor's rights are separate from the members rights and therefore outside the member's estate for IHT.

Trivial commutation death benefits

It's possible for individuals who receive small pensions on the death of another to commute the income for a trivial commutation lump sum, where the value of the lump sum is no more than £30,000. The intention is that these lump sums will be included when assessing IHT.

However, if the lump sum is generated from a dependant's scheme pension, then the value of the lump sum can be excluded, as the pension would have also been excluded.

Summary

Of course, these are draft rules and may be subject to change before they are enacted. However, it is now clear that the Government is committed to this path and alternative solutions for a tax on death benefit have been discounted. HMRC are expected to provide further detail on the process and mechanisms for schemes to pay IHT directly to HMRC in due course.