HMRC has issued fresh details about how inheritance tax (IHT) changes will apply to pensions. From April 6 next year, defined contribution pensions will be subject to IHT, which has a standard rate of 40%. While it is not expected to be an issue for many, Government figures suggest some 10,500 estates will pay IHT for the first time, and, due to rule changes, about 38,500 will be forced to pay more in the so-called “death tax”. The Treasury insists over 90% of estates per year will continue to pay zero IHT after the changes.
To help people prepare for the upcoming changes, HM Revenue and Customs (HMRC) confirmed more details in a technical note issued this month on how the Government’s plan will work. Under the new rules, IHT will be applied to a pension first. This differs to the current set up, which sees income tax applied to any withdrawals from a pension if the pension-holder dies after 75.
Beneficiaries will then be eligible for a statutory deduction, according to consumer watchdog, Which?. This means a beneficiary will pay income tax on what’s left after IHT has been applied.
Another change sees loved ones or executors being responsible for tracing all the deceased’s pensions and asking for valuations.
The full value of any pensions must be reported to HMRC along with the rest of the estate. Under the current rules, pension providers won’t discuss accounts without official probate documents.
But from April pension providers will have to share such information earlier and other proof will have to be submitted, such as a death certificate.
A new online tool yet to be launched will allow executors or loved ones to calculate the tax due from any pensions and rest of the estate.
They will then have to tell each pension provider what share of the IHT bill needs paying.
Settling any IHT due can still be done within six months of the end of the month when the deceased passed away.
Executors will still be able to tell pension providers to keep 50% of pension benefits for up to 15 months. An executor who suspects IHT might be due will want to consider doing this.
There will also be an option to instruct pension providers to pay any IHT due straight to HMRC.
Some existing exemptions will remain in place, including anything left to a spouse or civil partner. He or she will continue to be fully exempt from IHT.
Most death in service benefits will also remain exempt, but they may have to be reported to the taxman by pension schemes.
Pensions used to provide a guaranteed regular income for a child or dependant as opposed to a lump sum will also escape IHT. But the person in receipt of that income must meet strict criteria.
A flexible drawdown pot or one-off lump sum will be counted as part of an estate and may therefore be subject to IHT.
The new rules also apply to some overseas pensions held by UK residents and valuations from overseas providers will have to be converted into sterling using the exchange rate current on the date of death, according to Which?.