Pension Inheritance Tax proposals – further considerations

In our previous article of 21 November 2024 we outlined the proposals set out by the Chancellor of the Exchequer in her Budget Statement of 30 October 2024. 

The Consultation closed on 22 January 2025 and it has been reported that there were over 500 respondents – significantly more than HMRC obtained on the abolition of the Lifetime Allowance (LTA). That, in itself, is telling of the importance being placed by the financial services industry on the changes involved in bringing most pensions within scope of Inheritance Tax (IHT). We have been informed by HMRC that, having considered the feedback, it will provide draft legislation “later this year” and we expect that this will not be before the 2025 summer recess.

In the meantime, we thought it may be helpful to look at a couple of aspects which clients of Dentons might be thinking about in light of the proposed changes to the treatment of death benefits from Registered Pension Schemes.

A re-cap of how things used to be

Firstly, it might be helpful to remind ourselves of how death benefits were treated prior to the introduction of so-called “pension freedoms” in April 2015. Prior to the introduction of these, in many cases lump sums paid to beneficiaries were subject to a standalone tax charge of 55%. The age of the member on death (i.e. pre or post 75th birthday) AND whether or not funds had been crystallised are what determined if this 55% tax on lump sum death benefits applied. 

The Scheme Administrator of the pension scheme was responsible for paying the tax charge.

From 6 April 2015, a new set of rules came into effect and we saw the introduction of the considerable flexibility to cascade pension wealth through payments to “nominees” and “successors” – and the 55% tax charge was removed.

Why is this important?

We have outlined the former treatment of lump sum death benefit payments above simply as a reminder that pension scheme death benefits have not always been as tax efficient as they currently are – and also to highlight that finding liquidity to settle a tax charge from pension scheme assets is not a brand-new concept.

What if there is no liquidity within my pension scheme with which to pay an IHT bill at the time it’s due?

Given the nature of some types of investment within SIPP and SSAS arrangements (such as commercial properties, loans, unquoted shares and so on), it could be the case that an unexpected death could result in there being no liquid cash (or investments which can easily be sold to create cash) with which to settle any IHT bill immediately. 

Importantly, this aspect does not appear to have been considered within the consultation and it is likely that this has been a key item of feedback from various industry representatives.  

There may be various options which could apply, depending on a client’s individual circumstances. As an example, it might be possible for the pension scheme to borrow funds in order to settle an IHT bill. Depending on the provider’s proposition, schemes could borrow from a connected party (on demonstrably commercial terms) or from commercial lenders. Alternatively, it may be possible to sell some illiquid assets within the timescale by which IHT needs to be physically paid.

In the small self administered schemes (SSAS) world, it may be possible to find liquidity for one member’s death benefit payment (and potential IHT liability) across the overall scheme membership, given that the SSAS is a “common trust fund.” 

Example

Let’s assume we have a 5 member SSAS (members A, B, C, D and E) which owns a range of assets such as: 

• Commercial property – value £160,000
• Loan to employer – value £100,000
• Platform account – value £450,000
• Cash – value £5,000

Let’s also assume that the commercial property has only recently been acquired and is allocated entirely (notionally earmarked) to Member A, as all members have agreed to this unanimously. All of Member A’s £160,000 fund value in the SSAS is tied-up in the commercial property. As a result, Member A’s investment returns will come in the form of rental income from the property and Member A’s fund value will increase or decrease in line with the underlying value of the property.

Unfortunately, Member A dies on or after 6 April 2027. 

Firstly, there is very little liquid cash with which to pay death benefits to Member A’s beneficiaries and, in the early stages of ownership of the property, all of Member A’s fund value is represented entirely by bricks and mortar.

Secondly, there might be an IHT liability attaching to the SSAS because of the overall value of Member A’s estate - including his defined contribution pension scheme.

Potential solution

Given the common trust fund nature of the SSAS, and the notional earmarking of assets, it is possible that liquidity could be found within the scheme as follows:

Firstly, the commercial property is valued by a RICS Registered Valuer to confirm that it is worth £160,000. 

Next, let’s assume that the platform investment is split equally between Members B, C, D and E. If each agrees to swap £40,000 of platform investment in return for £40,000 of bricks and mortar, the SSAS trustees can then encash units to the value of £160,000 and these liquid funds can be used to pay death benefits and the IHT liability attaching to the pension scheme in respect of Member A. 

Members B, C, D and E now each have a notional £40,000 share of the commercial property and will receive their respective shares of the rental income going forward. The property has not been sold by the trustees as part of this process, so there are no conveyancing fees, no Stamp Duty Land Tax (SDLT) (Land and Buildings Transaction Tax (LBTT) in Scotland) considerations and so on.  

It's also worth noting that, had the property been owned across 5 SIPPs for the members, the same result could be achieved by each member’s SIPP formally buying out a share of the property from Member A’s SIPP, although this would involve conveyancing and potentially SDLT/LBTT and so on.  

Conclusion

Pension schemes remain a highly attractive method of long-term saving, despite potential changes to their IHT treatment, and you may find it beneficial to obtain sound regulated financial planning advice across your overall wealth portfolio in order to maximise tax efficiency. Dentons can provide you with factual information only.