Navigating New Rules: How Inheritance Tax on Pensions Will Be Handled

With it being proposed that defined contribution pensions are subject to Inheritance Tax (IHT) from 6 April 2027, understanding the practicalities of how this tax will be collected is crucial. While some details are still being finalised, a clear framework has emerged from consultation processes.

Who is Responsible for IHT on Pensions?

The responsibility for dealing with IHT on unused pension funds will be shared:

• Personal Representatives (PRs): These are the executors or administrators of the deceased's estate. From 6 April 2027, PRs will be liable for reporting and paying Inheritance Tax on any unused pension funds and death benefits.

• Pension Beneficiaries: Individuals entitled to receive the pension funds will also play a role. Pension beneficiaries will become jointly and severally liable for any IHT due on the unused pension funds and death benefits they are entitled to, from the point they are appointed. This means that HMRC can pursue any or all of the liable parties for the full amount of tax due.

Options for Paying IHT on Unused Pension Funds and Death Benefits:

Recognising the potential complexities, several payment options will be available:

• Pay directly from the free estate: PRs can pay the IHT using other funds available in the deceased's estate.

• Pension beneficiaries direct PSAs to pay: A new scheme will be set up to allow beneficiaries to instruct PSAs to pay the IHT directly to HMRC from the pension funds themselves.

• Pension beneficiaries pay directly: Beneficiaries can take their benefits in full from the pension and then pay the IHT directly to HMRC themselves.

Income Tax Consideration: Notably, Income Tax will not be due on the portion of relevant death benefits equal to the IHT due on that pension. This prevents a "double taxation" scenario where both IHT and income tax would apply to the same amount.

These mechanisms aim to provide clarity and flexibility in how IHT on pensions will be managed, though the increased administrative burden and liability on personal representatives and beneficiaries underscore the need for careful planning.