In each case it means the pension is included in the value of a person’s estate and this can apply equally to defined benefit and defined contribution pension schemes.
However, most pension death benefits are usually paid out at a scheme or trustee discretion. The estate is not entitled to the benefit and the member cannot dictate to whom the benefit is paid, resulting in schemes that distribute death benefits that are excluded from the person’s estate.
The planned change is to include schemes with discretionary disposal into the IHT net.
Based on the detail in the consultation, this would include almost all pensions (including dependants, nominee and successor pensions) into the IHT remit.
With dependant scheme pensions and charity lump sum death benefits being exempt.
Any part of the pension paid to a spouse would be deducted from the estate value, just like any non-pension asset that passed to a spouse on death where the spousal exemption will apply.
Much more detail is required to understand the detailed mechanics of how this change will work in practice but the principles could be likened to what happens to beneficial interest in a trust on death, known as the settled estate.
In this case, the IHT bill is split between the trust and the estate according to the proportion of the overall estate each component represents.
A simple example explains the theory.
Bob has never been married and has no children so he has a IHT nil-rate band of £325,000. On his death he has a pension fund of £400,000, which is going to be paid equally to his niece and nephew at the scheme’s discretion.
Bob also has assets of £200,000 outside his pension. His IHT liability is £110,000 (£600,000 - £325,000 x 40 per cent).
His pension scheme is two-thirds of his overall estate (£400,000 / £600,000). This will be liable for £73,333 and his estate will have to settle the rest of the IHT bill.
Once the pension scheme pays the IHT bill the beneficiaries can receive the rest of the value of the pension under the normal pension death tax rules. HMRC has some good examples in their consultation paper.
Many people use their pensions as intergenerational wealth transfer vehicles and where this is the case, plans for passing on wealth will need to be reassessed.
However, there is a great degree of detail needed from this consultation, with the potential for changes still to be made.
We also do not know at this stage if the natural IHT consequences of having an asset in your estate will follow – a key example of this being the loss of the residence nil-rate band if assets are more than £2,000,000.
