Recent HMRC clarification that pensions IHT liabilities can be paid by schemes has thrown up other practical issues, as David Downie, Technical Manager, Aberdeen Adviser, explains.
Whilst everyone was hastily flicking through the leaked OBR report on Budget Day there was one tiny nugget hidden away in the depths of the main budget announcement which will have significant impact on pension death benefits post April 2027.
Following lobbying from probate lawyers, HMRC have agreed that the legal personal representatives (LPRs) can inform a pension scheme administrator that it must hold back 50% of any death benefit which isn’t payable to a spouse or civil partner for up to 15 months to settle the IHT liability.
This gets the LPRs off the hook for IHT due on an asset which isn’t part of the free estate and one they are unable to collect in and distribute to the estate beneficiaries. But it doesn’t solve the biggest problem facing LPRs and beneficiaries.
Until the pension scheme administrators (PSAs) for every pension scheme held by the deceased have exercised their discretion over who is to benefit, the IHT bill cannot be paid, and probate cannot be granted. This will hold up the distribution of the estate to the beneficiaries.
The process
It is the deceased’s LPRs who are responsible for submitting the estate’s IHT return and paying any IHT due. This must be done before the deceased’s assets can be distributed to the beneficiaries.
From April 2027, this will include IHT on any unused pension funds that the deceased held, even though the LPRs are not responsible for collecting and distributing those pension assets. That task will remain with the PSA.
The process for this, as outlined in HMRCs consultation response, is that the LPRs will need to request valuations from PSAs for any pensions the deceased held at their death. The PSA must provide a valuation within 30 days of that request. Obviously, the more pensions an individual holds the more admin the LPRs must deal with. But that is only the start of the issue.
In addition to scheme valuations, the LPRs will also need to know if any of the pension death benefits are to be paid to an exempt beneficiary, such as a spouse, civil partner or charity. Without this information, the IHT liability for each of a client’s pension pots and their free estate cannot be calculated.
Exercising discretion
HMRC are unable to dictate how long a scheme takes to exercise its discretion over who death benefits are to be paid to. The PSA has a fiduciary duty to ensure that it has identified all the possible beneficiaries and fairly considered their interests and the wishes of the deceased scheme member. Only after they have undertaken this due diligence can they make their decision on who is to benefit. This may, and often will, take far longer than the 30 days in which they must provide the valuation.
Pensions which don’t have a death benefit nomination, or where the nomination was completed many years ago and where family dynamics may have changed, can slow down the decision-making process.
Paraplanners can help by reviewing death benefit nominations as part of annual client reviews. Whilst this isn’t binding upon the PSA, it does help demonstrate that the member’s latest wishes are considered.
The upshot of this is that the time taken to obtain probate will typically be determined by the speed of the last pension scheme to exercise its discretion. Until all schemes have determined who is to benefit, it’s not possible to know the IHT liability and how this will be apportioned between each of the pension schemes and the remaining estate. This creates a scenario where a small pension pot which is a relatively insignificant part of the wider estate may hold up everything.
The cost of delay
Generally, the IHT bill must be paid within six months from end of the month in which the member died. Failure to do so will usually lead to penalties and interest being applied. HMRC currently charge 8% interest on late payments of IHT, which can mount very quickly for large estates.
For example, a client dies with a taxable estate of £1.4M. After deduction of the NRB and RNRB, the estate has an IHT liability of £360,000 (£900k x 40%). But because the estate includes a pension pot of £40,000 where the PSA hasn’t yet determined who is to benefit, the IHT bill cannot be paid. For every month that IHT remains unpaid beyond the six-month deadline, the LPRs will be charged £2,400 in interest.
The benefits of consolidation
The risk of a pension preventing the distribution of the estate and running up late payment penalties can be reduced by consolidating them into a single scheme. Fewer schemes not only mean less admin for the LPRs, but also less chance of delay.
The benefits of consolidating pensions are well known and can include an opportunity to bring all pension assets under advice, improved benefit and investment options and lower charges.
Many clients have accumulated pensions across different employers and providers. Left unchecked, these fragmented pots can lead to unnecessary complexity both in retirement and on death. Consolidation isn’t just about tidying up – it could help to ensure a smooth transfer of wealth across the client’s entire estate.
