Changes to pension tax treatment create significant risks for personal representatives

From 6 April 2027, pension death benefits will be subject to Inheritance Tax (IHT) undoing decades of wealth planning advice that encouraged people to use pensions as a vehicle for avoiding death charges

From 6 April 2027, unused pension funds and most pension death benefits will form part of the deceased's estate for inheritance tax purposes. The PRs of the estate will calculate the inheritance tax liability on the estate as a whole, taking account of available exemptions, reliefs and nil-rate bands. The proportion of that liability attributable to the pension benefits will then be identified and allocated to the relevant pension beneficiaries.

This is likely to create difficulties for PRs because, perhaps surprisingly, the new rules make them responsible for paying any IHT attributable to the pension even though the funds remain under the control of the Pension Scheme Administrator (PSA).

It is anticipated that PRs will take “reasonable steps” to identify pensions at a very early stage. If such steps reveal a pension that may be subject to IHT, PRs should immediately issue a withholding notice to the PSA. The withholding notice is effective for 15 months after the date of death and requires the PSA to withhold a sufficient amount of the pension to cover the anticipated IHT liability. The withholding period gives the PRs time to investigate the exact IHT due before issuing a payment notice obliging the PSA to pay the tax to the PRs within 35 days. It should be noted, however, that a withholding notice should be issued promptly because, once the PSA has identified a beneficiary, they are entitled to distribute the benefits “without further delay” under the new rules.

Where the new pension rules could lead to disputes

This is how it is supposed to work in practice but there are clear risks for PRs who are unaware of a pension, overlook this requirement, do not act quickly enough or are unable to act due to, for example, other disputed issues with the estate.

This may result in a pension of significant value being distributed even though it should have borne a share of the IHT, leaving the PR facing difficult discussions with the beneficiaries of the free estate who are left bearing the tax.

This could result in disputes and litigation, including:

1. A claim by the PRs against the pension beneficiary. The beneficiaries of the free estate will want PRs to pursue the beneficiary of the pension if the pension should have borne a share of the IHT to recover the contribution

2. A claim by the PRs against the pension scheme. Such a claim may arise where the PSA distributes benefits prematurely or fails to comply with a withholding notice. However, it may be difficult to argue that the PSA acted prematurely if no withholding notice was issued

3. A claim by the beneficiaries of the free estate against the PRs. The beneficiaries may target the PRs if they have delayed and allowed the free estate to be devalued by, for example, their failure to issue a withholding notice that leads to costs being incurred by the estate seeking to recover the contribution from the pension beneficiary or worse if those funds are not recoverable

4. A contribution or indemnity claim between PRs. There may be disputes between PRs regarding who should bear responsibility for a failure to ensure a pension bears its share of any IHT

Significant changes will take effect from 6 April 2027, and it is vital that both PRs and beneficiaries understand their responsibilities and are properly advised.

Our Trust, Estates & Tax and Contentious Probate teams, both ranked in Band 1 by Chambers, are well placed to help ensure that all parties involved in the administration of the estate meet their obligations, and to assist should a dispute arise.