A former minister says significant changes are required for pensions IHT reform

The government is being urged by experts to alter the inheritance pension system to make it "more effective, efficient, and humane"

The process by which inheritance tax will be applied to pensions needs to undergo significant reform, according to industry experts, who also want the reform to be more equitable and compassionate.

The value of a pension does not count towards the nil-rate band or the total value of an estate subject to inheritance tax (IHT) since pensions are currently exempt from these calculations.

However, chancellor Rachel Reeves declared in the Autumn Budget of last year that pensions would be subject to inheritance tax starting in April 2027.

During today's (3 November) hearing of the House of Lords Economic Affairs Committee on the Finance Bill and changes to IHT, former pensions minister Steve Webb is urging the House of Lords to amend the proposed procedure for including pensions in IHT calculations.

In their joint statement, Webb, a partner at the consulting firm LCP, and Alasdair Mayes, the firm's head of pensions and tax, urge the inquiry to implement the changes they claim will make the procedure "more effective, efficient, and frankly humane."

"There will be a lot more work under the new regime for pension schemes and providers as well as for personal representatives handling estates," Webb stated. These issues might cause the tax collector and bereaved families to miss payments.

Families are already going through a tough moment, and if IHT is not resolved, they will now have six months to deal with the consequences, including interest and penalties.

It is already controversial to include pensions in the scope of IHT. A third of people are actively looking into ways to shield their pension from IHT, according to research conducted in October by wealth manager Saltus, and 30% are evaluating or modifying their retirement plans or pension funds before the change takes effect.

Alex Pugh, a financial planner at Saltus, stated, "The decision to bring pensions into scope from 2027 has really sharpened focus on long-term planning." According to Pugh, a lot of Saltus clients are inquiring as to whether the tax laws will be altered once more in the next Budget.

According to the LCP team, however, there are significant issues with the suggested system that should be resolved first.

What modifications to the IHT procedure for pensions are being suggested?

LCP's proposal calls for modifications that would improve the process' efficiency and fairness while fulfilling its declared goal of terminating direct contribution (DC) pensions in order to avoid IHT. These consist of:

Funeral payments and deferment lump sums are not included in the IHT net.

The policy of including pensions in IHT calculations is justified by the fact that some people have used DC pensions as a way to evade IHT. However, Webb points out that the proposed changes cover much more ground than just DC contributions and death in deferment lump sum payments. They also cover funeral grants from pension plans, the pensions of individuals who have passed away before beginning to receive their benefits, and the pensions of those who have left the company that provided the plan.

According to Webb, "it seems unfair to catch both of these systems in the scope of the policy, given that neither is being used to avoid IHT."

Protecting personal representatives from unjust exposure.

Although they might not have direct control over all of the funds in the case of pensions, personal representatives will be responsible for making sure that IHT is paid under the current framework.

A pension fund payable to a beneficiary who is not the personal representative is one example, according to Webb.

According to Webb, the solution to this issue might be to guarantee that representatives are only responsible for the IHT owed on the remaining estate or to grant them the authority to demand that the pension provider deduct IHT prior to disbursing payments.

A more equitable strategy for handling payment delays.

IHT must be paid within six months, and if this deadline is missed, beneficiaries may be subject to interest and penalties. Representatives are in charge of making sure this happens.

According to Webb, "they might face penalties for things that are out of their control, like not getting information about fund values and other beneficiaries in a timely manner." In these situations, it would seem appropriate to extend the deadline or, at the very least, waive the penalties and interest.

Taking care of possible payment delays.

Payments to eligible beneficiaries may be delayed if pensions are included in the IHT.

According to Webb, "under the new rules, it's unclear assets can be paid until the entire process is finished and the personal representative is aware of the value of all pension and non-pension assets and how these are to be divided between exempt and non-exempt beneficiaries."

This implies that even a payment to a spouse for whom no IHT is owed could be delayed for several months. Such payouts should be made available prior to the resolution of IHT issues.

Addressing informational delays.

Webb stated, "More needs to be done to ensure that pension schemes become aware of the death of a member as soon as possible due to the time pressure on this entire process."

He suggests mandating registrars to share death data more quickly and frequently or permitting the government's Tell Us Once service to share information with pension providers.

By enabling probate applications to be processed concurrently with IHT assessments, LCP also suggests lowering the overall process's end-to-end delay.

Assist grieving families in finding pensions.

Lastly, it might be challenging for grieving families to locate pensions, which could cause the estate assessment process to drag on even longer.

Bereaved families should have access to the new pensions dashboard once it is operational, and Webb suggested expanding the data it shows to include unspent pension balances. "Those attempting to track down every pension after a death would greatly benefit from this.