Pension schemes, life assurance and inheritance tax

News alert 2024/04

At a glance

At the Autumn Budget the Chancellor announced that most unused pension funds and death benefits would be brought into a person’s estate for inheritance tax purposes from 6 April 2027. 

Although this policy is intended to remove the opportunity for individuals to use pension savings as a vehicle to pass assets on to the next generation free of inheritance tax, the proposals appear to go wider than this and may have an impact on some life assurance death benefits. 

In this News Alert we take stock of this significant shift in pensions and death benefits tax policy, setting out some of the implications for pension schemes and life cover arrangements.   

Key actions

Trustees of pension schemes 

• Consider what information about the new regime should be provided to scheme members (Defined Contribution (DC) and Defined Benefit (DB)) now, including the opportunity to update expression of wish forms to take account of the different tax position from April 2027 
• Review the tax labels used when a pension is being purchased with DC funds 
• Review policies of trivially commuting DB dependant pensions where this could lead to a materially worse inheritance tax treatment  
• Ensure that your administrator is prepared to make the necessary updates to their processes ahead of April 2027 
• Consider responding to the consultation

Employers providing life cover 

• Check details of how death in service multiple of salary benefits are provided so an assessment can be made of whether they have the potential to be affected by the proposals and, if so, how the employer would be affected 
• Consider what information about the new regime should be provided to employees, including the opportunity to update expression of wish forms to take account of the different tax position from April 2027 
• Consider the level of life assurance cover provided 
• Draw up a plan to ensure any life assurance trusts registered with HMRC will be ready to calculate inheritance tax and pay it to HMRC if it is confirmed these arrangements are within scope, or to change to alternative provision if that will be more appropriate. 
• Consider responding to the consultation 

The detail

As part of the Autumn Budget 2024, the Government has published a consultation setting out details of how different pension and lump sum benefits payable on death will be treated for inheritance tax purposes from 6 April 2027 and to seek views on the proposed process for implementing these changes.  

Under these proposals: 

• Unspent DC pension pots along with nearly all death benefits payable from trusts registered with HMRC will be included in the deceased’s estate for inheritance tax purposes from 6 April 2027. 
• All lump sum death benefits paid from DB and DC pension schemes are within scope and it appears that Life Assurance Only schemes registered with HMRC are also included – the proceeds of many Group Life policies are therefore at risk of falling within scope – but the consultation document is not definitive on this point.  
• Many survivor pensions purchased with DC funds will also fall within scope, even it appears if purchased on retirement (before or after 2027); not just those purchased on death. 
• All the above benefits will be considered alongside assets in an individual’s estate for inheritance tax purposes – with tax due depending on the overall size of the combined pension, death benefit and other estate assets. The standard inheritance tax rules include ‘nil-rate’ thresholds and exemptions for transfers of assets on death to a legal spouse or civil partner. 
• Pension scheme administrators will be responsible for reporting and paying any inheritance tax due on the benefits they pay and will have to work with the Personal Representative managing an individual’s estate to establish the tax due. This is likely to significantly delay and complicate the payment of death benefits. 
• There will also be a significant new burden on employers with Life Assurance Only schemes registered with HMRC, if it is confirmed such schemes fall within scope.  
• The income tax treatment of death benefits is unchanged, so where income tax is currently due on death benefits as they are paid to the recipient, this will continue to be the case from 2027. This will mean that some benefits are subject to both inheritance tax and income tax – for example lump sums paid on death of an individual over age 75, where paid more than two years after notification of death, or where the lump sum exceeds the Lump Sum and Death Benefit Allowance. 
• The inclusion of nearly all death benefits will remove the current differences between those operating on a “discretionary” basis (where trustees decide who will receive death benefits) and those operating on a “non-discretionary” basis (where members choose who will receive death benefits and which are already chargeable to inheritance tax). 
• The changes will introduce an inconsistency between certain survivor pensions and it appears an inconsistency between personal life assurance set up under trust and group life assurance set up under a trust registered with HMRC. The differences between life assurance delivered through an excepted life policy and that delivered through a trust registered with HMRC could become more significant if excepted life remains exempt from inheritance tax, but registered arrangements are not. 

In the following sections we highlight some of the key issues and anomalies in the proposals, and how these could impact trustees and employers, both now and from 2027 onwards.   

The Government consultation runs until 22 January 2025. Whilst the consultation itself focuses on the implementation of the changes it seems clear that these proposals have the potential to go far beyond what was apparent from the initial announcement in the Budget. Given this, it is likely that many will also wish to use the consultation to provide comments on the policy in addition to the implementation details.  

Joint life annuities – different treatment to scheme pensions? 

Under the proposals almost every type of death benefit will be included in the value of an individual’s estate for inheritance tax purposes – with the only exclusions being dependants scheme pensions (pensions paid to a survivor usually from a DB arrangement) and charity lump sum death benefits.   

Crucially, dependants’ annuities are included on the list of benefits subject to inheritance tax. As things stand, this would appear to mean that the survivor element of joint life annuities (future and existing purchases) is within scope of inheritance tax on death of the first life, if the second life is not exempt (ie if the second life is not the legal spouse/civil partner). This is not just relevant for external annuity purchases by DC schemes (both trust and contract based), but also where trustees of a DB scheme with DC AVCs have the option of purchasing an annuity from the DC AVCs.  

However, other tax structures may be available. Subject to a number of conditions, it is possible for a scheme to offer members the option to use DC pension pots to secure a scheme pension (either within the scheme or directly with an insurance company), rather than purchasing an annuity. This could have a very different inheritance tax treatment.   

Lump sum death in service benefits 

Life assurance benefits can be provided in many different formats – sometimes within a pension scheme (which may insure or self-insure the benefit) and sometimes through a stand-alone group life policy.  

Normally group life assurance policies are set up under trust, and benefit from the inheritance tax exemption that currently applies. Whilst these trusts are not occupational pension schemes in the eyes of the DWP they are normally registered with HMRC and treated in the same manner as pension schemes under tax law – indeed many group life insurers require this. Payments from registered group life trusts therefore appear to be in scope of inheritance tax from 2027. The intention of the consultation reference to life policy products being excluded from inheritance tax is not clear but appears to relate only to life policies providing benefits outside a trust registered with HMRC. 

It is easy to see how inheritance tax could be due on lump sum death in service benefits for not just the highest earners. By the time non-pensions assets and the accumulated DC funds have been considered, the lump sum death benefits payable for even moderate earners could well exceed the nil-rate threshold. 

Other group life policies set up as “excepted” life arrangements aren’t registered with HMRC. This type of policy has been potentially attractive because previously the lump sum benefits provided did not count against the Lifetime Allowance or impact any Lifetime Allowance protections and now do not count against the Lump Sum and Death Benefits Allowance. It appears that these excepted life policies will continue to remain outside of inheritance tax after 2027 as there has been no reference to them being brought into scope of inheritance tax – which is likely to increase their popularity.  

Significant delays in payment of death benefits are possible 

The proposed process for managing potential inheritance tax charges is a particularly worrying aspect of the proposals and could cause significant delays and complications for paying out benefits on death. 

Under HMRC’s current proposals, any trusts registered with HMRC will need to liaise with the Legal Personal Representative managing an individual’s estate more extensively and for almost every death benefit payable, even if the benefit is due to the legal spouse or civil partner.  

The proposed process requires the following steps: 

• The Legal Personal Representative notifies each pension scheme in which the member holds benefits of the member’s death.  
• Each pension scheme confirms to the Legal Personal Representative details of the (gross) death benefits payable from its scheme and who they will be paid to. Where discretion is involved, the relevant information on potential beneficiaries will need to have been gathered and considered before the scheme can say who the recipient will be.
• Once the Legal Personal Representative has established the value of the entire estate and death benefits, they establish which assets are exempt and apportion the nil-rate band across remaining different components on a pro-rata basis, notifying each pension scheme of their part of the nil-rate band. HMRC have said that they will produce a new calculator to help Legal Personal Representatives with this.  
• The pension scheme calculates how much inheritance tax is due from their scheme. It is then responsible for reporting and paying to HMRC the inheritance tax charge due on the benefits, before paying the net death benefits to the relevant beneficiaries. 

These proposals are likely to significantly delay the payment of death benefits. This will be equally true for all death benefits payable, however small or large, as it has been proposed the same process will need to be followed for all benefits. Death benefits that could be caught by this include not just multiple of salary death in service benefits but also funeral grants, refunds of contributions, five-year guarantees and trivial commutation of survivor pensions on death.   

Supporting members 

The changes being made are complex and go far beyond the removal of DC pensions as an inheritance tax planning vehicle. The impact spreads into almost all death benefits payable by occupational pension schemes and potentially many group life assurance arrangements.  

Trustees will need to update their scheme documents and communications to ensure they reflect the new rules and may also want to provide additional proactive communications to highlight the changes to members. 

Members who might be affected by the changes should seek financial advice to consider their own circumstances. We can help pension schemes prepare for possible changes that members may wish to make.  

Employers may wish to review the level of cover provided or to introduce more flexibility in flex packages to allow employees to vary the cover they select to enable their beneficiaries to remain in the same position net of tax.