Andrew Tully: The government needs to look at alternatives to IHT on pensions

HMRC’s consultation around the inclusion of pensions within the scope of Inheritance Tax (IHT) from April 2027 has recently closed.

Many of the responses are likely to emphasise that this change will provide poor outcomes for customers, beneficiaries, personal representatives (PRs), the industry and HMRC.

Most pension schemes operate death-benefit payments under a discretionary disposal procedure. This can be a relatively complex position, especially if blended families are involved or there are family disagreements.

The scheme administrator (SA) is often not informed of death until weeks or even months later, as bereaved relatives make their way through a deceased’s records.

The SA then needs to consider various evidence when making its decision. This can take time and is usually a reiterative process, evolving through discussion with various parties.

This change will provide poor outcomes for customers, beneficiaries, personal representatives, the industry and HMRC

Including pensions within IHT means the SA will need to have more continuous dialogue with the PRs in addition to the existing discussions.

For example, they will need to obtain information about any nil-rate band (NRB) that may be apportioned to the scheme, which the PRs will only be able to determine once they know which beneficiaries the SA has chosen.

The deadline for payment of IHT is six months after the month in which death occurred. Many clients will have multiple pension arrangements.

Adding the complexity of coordinating with all these schemes creates additional onerous work for PRs (who are often family members and not professionals) and potentially increases costs if solicitors are involved in assisting PRs.

If even one of those pension schemes is slow making decisions or obtaining information, it will hold up the entire process.

The PRs – without knowing whom the pension schemes are going to pay benefits to – will be unable to apportion the NRB between the various schemes and the rest of the estate, and therefore no accurate payments can be made to beneficiaries or HMRC.

That would cause late interest payments to be levied, which schemes would generally need to pass on to the beneficiaries by reducing death-benefits payments.

The likelihood of beneficiaries being chosen and assets sold within the six-month period is very low

The alternative is for a SA to make payment in advance of the receipt of NRB information.

In practice, as the SA is liable for IHT, that will mean assuming the entire benefit is subject to 40% IHT if the payment is to a non-spouse and paying the remaining 60% of benefits to the beneficiaries.

This alternative route will cause confusion, stress and many complaints.

Illiquid assets, which can include commercial property and property funds, are a further issue.

In these cases, the likelihood of beneficiaries being chosen and assets sold within the six-month period is very low, making the imposition of late payment charges almost inevitable.

Those who have recently experienced the death of a family member are more likely to display characteristics of vulnerability, especially as many may also have concerns or issues around future financial security.

Together, this means these individuals may be at greater risk of harm and be more susceptible to behavioural biases.

Including pensions with the estate for IHT is likely to drive behaviour that focuses on speed of process – given the six-month window – at the expense of client understanding and client support.

Ideally, firms will have customer service that responds flexibly to the needs of vulnerable consumers. And, for some bereaved clients, that may mean taking slightly more time to understand and consider options, rather than rushing into decisions.

Including pensions with the estate for IHT is likely to drive behaviour that focuses on speed of process

Overall, this process, with its very tight deadlines and financial penalties, doesn’t fit well with the support firms may want to provide to vulnerable customers.

As well as these problems and others, the inclusion of pensions within IHT may discourage people from saving towards pensions, as well as encouraging more people to withdraw more as they move through retirement.

This could, for example, mean many will have less capital wealth to cope with the costs of long-term care and may need greater state support than would previously have been the case.

Given all of this, I hope the government explores other options that can achieve its policy objective, rather than simply focus on how pensions could be included in the IHT environment.

Andrew Tully is technical services director at Nucleus