Budget 2024 – Taxing of Pension Pots in the future

Budget 2024 – Taxing of Pension Pots in the future

The government announced in the 2024 budget that it plans to introduce legislation to include unused pension funds and death benefits payable from a pension into the total value of estates, which means they will be brought into inheritance tax (IHT) for the first time from 6 April 2027.

Under the proposals, which are a reversal of the 2015 pension freedom rules, pension funds will be taxable under IHT again.

From 6 April 2027, pension scheme administrators (PSAs) will become liable for reporting and paying any IHT due on unused pension funds and death benefits. They will have to report details of unused pension funds and death benefits payable in respect of a deceased member to HMRC and pay any IHT attributable to those benefits. 

It will be absolutely critical to make sure these filings are correct and where multiple pension schemes are held by the deceased, which is often the case for private pension holders, the PSAs will have to liaise with the personal representatives (PRs) of the estate and executors to ensure all the correct pension fund information is available.

Currently, personal representatives (PRs) are responsible for reporting and paying any tax due for non-discretionary pensions schemes which are included within the value of a person’s estate within six months of the death. 

However, in the future, the PSAs will pay the IHT bill which means that tax is deducted at the source of the pension fund, avoiding complications for beneficiaries and executors facing often unexpected tax bills as few would really know about the scale of a loved one’s pension pots at death or their financial value. 

HMRC stressed: ‘Requiring inheritance tax to be paid directly from pension funds will also prevent an additional income tax liability becoming due on the funds used to pay the inheritance tax.’

However, the new system will put the onus on personal representatives dealing with estates to provide PSAs with details of the nil-rate band apportionment for the pension element of the estate, which PSAs will need to be able to calculate how much IHT is owed on the pension element of the deceased’s estate. 

The tax bill will be high for pension savers who die with an unused pot. For example, someone with a £100,000 pot at death could face an IHT tax bill of £28,181.82, depending on whether they have used the IHT tax-free allowance or pay higher rate tax.

The Treasury have stressed that – ‘This will restore the principle that pensions should not be a vehicle for the accumulation of capital sums for the purposes of inheritance, as was the case prior to the 2015 pensions reforms.’

Under pension rules, PSAs are required to respond to requests for information from PRs within two months and inform PRs within three months of paying a relevant death benefit. Tax-free death benefit lump sums also become subject to income tax if they are not paid out by PSAs within two years of the member’s death.  

Most UK pension schemes are discretionary defined contribution and defined benefit schemes held by private sector workers, which currently fall outside IHT. The majority are contributory pensions with the days of generous final salary schemes now long gone in the private sector.

The new rules will bring holders of discretionary pension schemes in line with the IHT position for public sector pensions such as the NHS scheme, which is a non-discretionary scheme and is treated as part of an individual’s estate for IHT purposes.

Effective date

The rule change will come into effect from 6 April 2027 and is expected to raise £1.34bn a year from 2028-29, rising to £1.46bn in 2029-30. However, the Institute for Fiscal Studies (IFS) projects a tax gain of around £2bn a year once the system is up and running.

The Treasury’s estimates take account of a behavioural response as individuals are likely to restructure their estates by increasing the rate at which they draw down their unused pensions or make greater use of other tax reliefs and exemptions.

The closing date for the pension pot consultation is 22 January 2025.