Bringing inherited pensions into inheritance tax (IHT) from April 2027 could lead to major delays and stress for grieving families, a former pensions minister has warned.
Delivering Labour’s first Budget in 14 years on Wednesday, Rachel Reeves said she would “close the loophole created by the previous government,” and move inherited pensions under the scope of IHT.
Experts have warned this will have an impact on planning, especially for those with larger estates and pension pots.
Sir Steve Webb, former pensions minister, said: “Bereaved relatives already face huge challenges in winding up the financial affairs of a loved one, including delays in obtaining probate and the need to pay IHT bills before finances may become available.
“Including pensions within the scope of IHT will add greatly to the burden which families face.
“People will need to know which pension schemes to contact, will have to rely on the efficient administration of pensions – with the whole process on hold until the slowest scheme has replied – and then potentially wait months more before death benefits and pension balances can be released by the scheme.”
IHT is currently 40 per cent and is usually paid on the value of a deceased person’s assets above a threshold of £325,000.
Currently, any money saved in a pension does not count towards this, but as of April 2027, inherited pensions will be included.
According to the Treasury, bringing unspent pots into the scope of IHT will affect around 8 per cent of estates each year.
The measure is forecast to raise £640m in 2027-28, rising to £1.3bn in 2028-29 and £1.5bn in 2029-30.
The threshold was already due to remain frozen until 2028, but the change will drag a higher number of estates above it as asset and property values increase over time.
More estates will owe IHT as a result, at the standard 40 per cent rate.
Ms Reeves said: “The Government recognises people want to pass on their assets to their families, but the Government is making the inheritance tax system fairer by ensuring that wealthy estates contribute more to the public finances.”
At present, bereaved families already face two major challenges when it comes to dealing with IHT, according to Sir Steve:
- IHT bills have to be paid before probate can be secured;
- Obtaining probate itself can take many months, meaning finalising the financial affairs of a loved one can already be a drawn-out process.
But the details of the proposals for including pensions in IHT suggest that in cases where pensions form part of the estate, “the whole process will become much more convoluted”.
Sir Steve added: “This could lead to delays, including delays in releasing death-in-service lump sums. And these lump sums themselves could be much reduced if subject to tax of up to 40 per cent.”
The bereaved person then has to pay the balance of any IHT bill which does not arise from the pensions, such as the charge on property or other assets.
Sir Steve said: “The whole thing could turn into a bureaucratic nightmare for grieving families. If this proposal is to go ahead, the Government will need to come up with a much more streamlined process than is currently proposed.”
According to official estimates, around 49,000 estates per year which include pensions will face an IHT bill. This comprises 10,500 who would not have faced IHT at all if pensions were not included, and 38,500 who were already in the IHT net but will now face an additional bill.
How will inheritance tax for pensions work?
According to the Government’s consultation on the proposed change, where the deceased person has one or more pensions which form part of the estate, the bereaved person will have to notify “relevant” pension schemes of the death, and request information such as fund values or death benefit entitlements.
The pension scheme will then have to show whether any pension balances or death benefit entitlements exist, who are the nominated beneficiaries of those benefits, the amounts due to each, and how much of the lump sum allowance the deceased member has used up.
Once the bereaved person has assembled this information from all pension schemes, plus all other information about assets in the estate, they will use a HMRC online calculator to work out if any IHT is due.
If it is, they will also have to work out how the nil-rate band is to be apportioned between different assets, including each pension.
Then, the bereaved person will have to notify each pension scheme of its share of the IHT bill. Each scheme will report to HMRC, who will issue an IHT demand within six months of the death.
The scheme then pays its share of the IHT bill and makes payments to beneficiaries net of IHT.