Inheritance tax on pensions

In the autumn 2024 budget, the government announced proposals to bring death grants into scope for inheritance tax (IHT) purposes. The proposed approach placed the responsibility for reporting and paying IHT onto pension scheme administrators.

Many respondents to the consultation, including Hymans Robertson, pointed out that this approach introduced considerable complexity and relied on unrealistic timeframes.

Thankfully, the government has listened to responses and is proposing a new approach to take effect from 6 April 2027. The main principles of this new approach are set out below.

Personal representatives (PRs) take the lead

Personal representatives (PRs), who are already responsible for administering estates, will be liable for reporting and paying IHT on certain death benefits.

Death in service lump sums excluded

Death in service lump sums will be excluded from IHT consideration.  This applies regardless of whom the death grant is paid to.

Clearer responsibilities for administrators and PRs

PRs must gather information about relevant death benefits. In the LGPS, this will mean death grants paid on the death of a deferred member or pensioner. The pension administrators must provide this information within four weeks of being notified. Once they’ve decided how the death grant will be distributed, they must inform the PR.

PRs will then tell both the pension beneficiaries and the administrators how much IHT is due on each person’s share.

Three ways to pay IHT

IHT liability can be paid in one of three ways;

• PRs can pay the full tax liability from the rest of the estate. If the death grant beneficiaries are also beneficiaries of the rest of the estate, there is no further action. If the pension beneficiaries are not beneficiaries of the rest of the estate, PRs can recover the appropriate liability from the pension beneficiaries and distribute to the beneficiaries of the rest of the estate. 

• The pension beneficiaries can direct the pension scheme administrators to pay the tax and reduce their benefits accordingly. 

• The pension beneficiaries can take their benefits in full and pay the IHT directly to HMRC.

A better outcome for LGPS administrators

This new approach will place additional responsibilities onto LGPS administrators who will need to revise processes; however, it is a significant improvement on the government’s original proposals.

If you would like to discuss the changes being proposed in further detail, please get in touch.