Bereaved families could be denied half the pensions left to them by loved ones while an inheritance tax bill is settled, under new rules from next April.
People in charge of winding up estates will be allowed to stop pension firms paying out pensions in full if they think 40 per cent death duties might be due.
The new power to partially withhold pensions for up to 15 months after someone dies was clarified this week by HM Revenue & Customs.
The taxman is fine tuning how unspent pensions will be assessed once they become liable for inheritance tax – along with savings, property, investments and other assets – from spring 2027.
Sorting out estates is set to become far more onerous because grieving families will have to chase up pension companies for vital information.
Stiff interest payments, currently set at 7.75 per cent, could be levied if they fail to track down all pensions, as well as other assets, and work out and settle the bill within six months.
Inheritance tax is levied at 40% on estates above a certain size, starting at £325,000 if you are single, or £650,000 for a couple
The Government has refused to extend this inheritance tax deadline despite the extra hassle executors of wills or administrators are likely to experience when winding up estates.
These are usually a family member or friend, but sometimes a paid professional like a lawyer. They are known in official jargon as ‘personal representatives’.
Their new ability to delay the payout of 50 per cent of pensions could put personal representatives and beneficiaries at loggerheads and cause disputes within mourning families.
Inheritance tax is levied at 40 per cent on estates above a certain size, but you will need to be worth at least £325,000 if you are single, or £650,000 jointly if you are married, before becoming liable for death duties.
If you are passing on your home to direct descendants, that rises to £500,000 and £1million – check our guide to inheritance tax including the key thresholds.
Former Pensions Minister Steve Webb, now a partner at LCP, says of the new ‘withholding’ power: ‘This one is quite nuanced – it’s obviously not good for beneficiaries that they may have to wait longer, but it’s helpful to the executor to be able to put a hold on part of the payment to cover the IHT bill.’
Webb, who is also This is Money’s retirement columnist, adds: ‘I suspect professional executors will have a pretty good sense early on as to whether IHT is a risk or not. But there’s certainly a strong incentive to put a hold on just in case.
‘I think this is a particular issue where it’s the next generation who are inheriting. If it’s a spouse then hard to see any IHT risk.’
Vital source of income
Webb points out that pensions have often been a vital source of income for families following a death, as they are outside the estate so can be accessed quickly.
Neil Jones, tax and wealth planning specialist at Standard Life, says the ‘withholding’ rules mean the person responsible for handling an estate can ask a pension provider to hold back some of a pension while they confirm the total value of the estate and work out whether any IHT is due.
‘This is important because IHT is generally payable within six months, whereas pension providers may take longer to confirm who will receive the benefits, potentially leaving uncertainty in the meantime.’
He notes that a pension provider might also be instructed to pay any IHT directly to HMRC from the pension itself.
‘The withheld money is not lost, it is simply delayed, and any remaining funds are paid once the tax position is finalised.
‘Not all payments are affected. Benefits paid to a spouse or civil partner are usually exempt from IHT, and certain other benefits can still be paid out straight away.’
Jones adds: ‘While this process may delay access to some funds, it is designed to protect beneficiaries by ensuring the correct tax is paid and helping to avoid unexpected liabilities later on.’
He says that one of the biggest challenges for families will be identifying all a deceased person’s pension pots.
‘Those approaching retirement today typically have two or three pensions, but younger generations are expected to have 11 or 12 pots over their working lives, largely due to job mobility and pensions auto enrolment.
‘Consolidating pension pots may make things simpler for personal representatives to manage depending on circumstance, but it’s important to understand whether bringing these together could mean losing any valuable features or guarantees before making changes.’
How long will it take to work out and pay IHT?
Neil Jones of Standard Life has compiled the timeline below, and also see This is Money’s guide to paying inheritance tax.
From day one – notifying pension providers
After the death, the personal representatives inform pension providers or scheme administrators that a person has died.
The pension provider then begins the process of deciding who should receive the benefits, based on the scheme rules.
At this stage PRs may ask the provider to temporarily hold back some payments while the tax position is worked out.
Some payments such as those to a spouse can still be made straight away.
Neil Jones: A pension provider might be instructed to pay any inheritance tax directly to HMRC from a pension
Months one to three – working out the value of the estate
In the first few months, PRs calculate the total value of the estate.
This includes non pension assets like property or savings, and the ‘notional value’ of pension benefits that count for IHT.
If the total value exceeds the tax-free thresholds they submit an IHT return to HMRC and confirm how much tax is due.
Within 6 months – paying the bill
Any IHT due must normally be paid within six months of the end of the month of death. After this point, interest may start to accrue.
There are three main ways the tax can be paid: from the estate’s general assets; directly from the pension, paid by the provider to HMRC; and by the beneficiaries themselves.
For up to 15 months – withholding pensions temporarily
To ensure there is enough to cover any tax bill PRs can ask the pension provider to hold back part of the pension, typically up to 50 per cent of the taxable amount. This can last for up to 15 months while everything is finalised.
This means beneficiaries may receive some money initially, with the rest paid later once the tax position is clear.
After an estate is wound up
If a previously unknown pension is discovered after the estate has been settled the PRs are usually not responsible for the tax on that pot.
Instead, the beneficiary becomes liable for paying any IHT due.
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