Last week the Government announced it was pushing ahead with its plan to bring discretionary pension scheme death benefits within the scope of inheritance tax for the first time.
This announcement was probably not a surprise, although some in the pension industry had been trying to persuade the Government to either abandon the plan or at least modify it.
A policy paper was published on the same day in which the Exchequer impact is estimated to bring in an additional £1.46bn to the treasury by 2029 to 2030.
There were two concessions made which have been welcomed by pension commentators. Firstly, pension schemes will not after all be required to handle the reporting and payment of IHT on unused pension funds on death and this responsibly will shift to the personal representatives (PRs), or executors, of the estate.
Secondly death in service benefits from registered pension schemes will be excluded from the process.
The Government also confirmed that where pension assets cannot be liquidated to pay IHT, it will be possible for it to be paid from other monies from inside the estate.
This leaves clients and advisers facing a seismic shift in the tax treatment of pensions and fundamentally how pension pots will be treated in estate planning. The Government has made clear its philosophy in this, that a pension is something that is primarily to be used for providing income in retirement, rather than passing a significant amount of money to dependants shielded from inheritance tax.
It also reinforces the importance of members receiving financial advice before making big financial decisions. Of all the major taxes which ordinary people are likely to face in their lifetime, inheritance tax is arguably the most complicated, if not the most unfair, but there are usually means of mitigating some if not all of it. It therefore is an area where the expertise of someone suitably qualified will be absolutely vital.
It is also arguably disingenuous to suggest that only a small percentage of wealthy individuals will be affected by this change. If you live in the South East of England for example, you will only need an average size four bedroom house and a healthy (but not necessarily exceptional) sized pension pot to stray beyond the maximum £1,000,000 combined total of two nil rate band allowances and two residential nil rate band allowances.
With these bands having been frozen for many years now and no confirmation that they will be uplifted in the future, increasing numbers of families are finding themselves in scope for this most punitive of taxes (one 40% rate for all in scope).
For advisers then it will be important to be on the ball in this area. Firstly and most importantly, review member expressions of wish nominations and ensure they are a) up to date and b) correct, based on the specific circumstances relevant to that client. For example, it may not always be prudent now in all cases to automatically name a spouse as a beneficiary, depending on the value of the assets held by each partner.
Secondly, we can expect the use of trusts to become more popular. Advisers may wish to look at spousal by-pass trusts or other legacy planning tools.
Thirdly, making use of the lifetime transfer regime, advisers may wish to discuss with clients the possibility of gifting pension commencement lump sums or income drawdown withdrawals.
There is of course a possibility that the final form of these IHT rules may change between now and April 2027, but at this stage it does appear unlikely.
But finally, despite these changes, pensions remain incredibly tax efficient tools for building up funds for retirement and with an old age pension provision crisis looming not far down the line it is important not to let the potential inheritance tax sting in the tail devalue them.
More than ever before right now, we need people to be making contributions to their pensions. We can only hope that the Government does not take any further action which might discourage the take up of pension saving.
Steve Berridge is Technical Manager at IFGL Pensions
