The Autumn Budget 2024 was the first Labour Budget in almost 15 years and there was a great deal of speculation beforehand on what it might contain.
Introduction
Pensions taxation was seen as one of the areas in which changes could be made given the restrictions on potential sources of revenue following Labour’s manifesto promise that it “will not increase taxes on working people”. Labour has noted on more than one occasion that difficult financial decisions need to be made taking into account the need to deal with the £22bn projected overspend ‘inherited’ by Labour and a bumper £40bn of tax rises were announced in the Budget.
All but one of the key pensions tax reforms that were mooted as possibilities before the Budget (including moving the rate of tax relief on pension contributions to a flat rate, reducing the amount of tax-free cash, and making employers pay national insurance on pension contributions) did not materialise.
The Budget contained just one headline pensions tax change with a passing nod to other pension measures such as pension investment in productive finance, the current pensions review and changes to overseas pension treatment. As from 6 April 2027 the “loophole created by the previous government” will be closed and both defined benefit (DB) and defined contribution (DC) “inherited pensions” will be brought “into inheritance tax” (IHT).
The IHT announcement was not completely unanticipated so has not come as a total surprise. Nevertheless, it represents a significant change for both defined benefit DB and DC arrangements and goes substantially beyond reversing the changes introduced by the previous government. Of the authorised pension death benefits listed in the Government’s 30 October 2024 IHT consultation, the only ones that will not be included for IHT purposes will be a dependant’s scheme pension and a DC charity lump sum benefit (which is included in the estate for IHT but which is exempt if paid to a qualifying charity).
Bringing inherited pensions into the IHT regime will mean that if the value of pension savings takes the value of the deceased’s estate over the IHT threshold (currently £325,000 and remaining at this level until 2030), tax will be levied (subject to other exemptions that might apply, such as the main residence exemption). The current IHT rate is 40%.
IHT and pensions – how will the changes work?
What are the main drivers behind the IHT pensions change?
In addition to creating government revenue, the main driver behind the new IHT pension rules is to:
- make the IHT system ‘fairer’ by removing the distortion in treatment between discretionary benefits (not presently subject to IHT) and non-discretionary ones (currently, within scope of IHT);
- stop pensions being used as a tax-free way to pass on wealth as an inheritance; and
- to make sure that pensions tax relief is being used for the purpose for which it was set up, to “encourage saving for retirement and later life”.
What amount of revenue will be raised for the Government by the change?
| 2027/28 |
£640m |
| 2028/29 |
£1.34bn |
| 2029/30 |
£1.46bn |
The Government estimates that 1.5% of total deaths will result in IHT being paid where they would not have previously and that approximately 38,500 estates will pay more IHT than before the changes.
What further information do we have about the change?
Some of the detail as to how the IHT pensions change will work is contained in the IHT consultation which closes on 22 January 2025. Consultation on the draft legislation needed to make the changes will take place in 2025.
As from 6 April 2027, most unused pension funds and death benefits in UK registered pension schemes and Qualifying Non-UK Pension Schemes will be treated as part of a person’s estate for IHT purposes. This means that the present exemption from IHT because a pension payment is paid under discretionary trust will end.
As the Office for Budget Responsibility’s (OBR) October 2024 economic & fiscal outlook notes, this will affect “uncrystallised DC pensions, crystallised DC pensions not invested in annuities, and lump sum death benefits from defined benefit pensions”.
Death benefits and IHT position from 6 April 2027: Annex B of the consultation contains a table detailing the different authorised death benefits, whether the benefit is DB or DC (or both), a description of the benefit and whether it will be included for IHT purposes from 6 April 2027. The only listed death benefits that are not included are a DB/DC dependant’s scheme pension and a DC charity lump sum death benefit.
Income tax: making the scheme administrator responsible for paying IHT avoids an additional income tax liability arising when a beneficiary has to use pension funds to pay the IHT liability (see further below). The changes mean that where IHT arises, both an IHT and income tax charge could arise on the death benefit provided.
Life policy products: The consultation also says that “All life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the changes in this consultation document.” Further details of precisely what this will cover are not provided.
Unauthorised payments in scope: The consultation also confirms that “Any unauthorised payments made from a deceased member’s fund will be in scope of” IHT.
Case studies: Several case studies setting out how the new provisions might work in different circumstances are included in the consultation.
Who will be responsible for reporting and paying IHT?
Scheme administrators (in a trust scheme, typically the trustees but which duties can be carried out by an authorised practitioner, usually the provider of scheme administration services) will have to report to HMRC when an IHT liability arises and pay any IHT due. To do so they will need to liaise with the deceased’s personal representatives.
The consultation explains how IHT will be calculated and paid by administrators. HMRC will set up a calculator to allow the PRs to calculate the IHT nil-rate band that will apply to unused pension funds or death benefits.
What are the practical implications of the IHT pensions announcement?
The practical implications of this are that:
- beneficiaries of deceased members may effectively receive less benefits from pension schemes (including DB schemes) if IHT is applied as a result of the benefits payable taking the value of the deceased’s estate over the threshold;
- beneficiaries of deceased members, where that member was over age 75 at the date of their death, may receive benefits subject to the double taxation of both IHT and income tax, significantly reducing the value of the benefit;
- it may well trigger an increase in withdrawals from DC pension schemes as pensioners seek to mitigate any potential exposure to IHT for the intended beneficiaries of their estate;
- it may also cause a reduction in future pension savings being made by some, as there is less incentive to do so from a tax-planning inheritance perspective;
- employers may wish to consider providing death benefits under an insurance wrapper rather than through a pension scheme (if doing so would be out of scope for IHT purposes from April 2027);
- individuals may decide to distribute more wealth in their lifetime and/or enter into other tax planning arrangements, for example, gifts are subject to an IHT exemption if made more than 7 years before death. As the OBR’s outlook notes, the extent and manner of any restructuring in response to the IHT on pensions measures may not be known for several decades.
Other Budget announcements with implications for pensions
The following Budget announcements also have relevance to or are pensions related.
Employer’s National Insurance contributions
Although the exemption for pension contributions was not tinkered with, employers’ National Insurance contributions will increase by 1.2% to 15.0% from 6 April 2025. This, together with the 6 April 2025 lower threshold triggering payment of employer Class 1 NICs (from £9,100 p.a. to £5,000 p.a.), will provide a large proportion of the £40bn tax rises announced in the Budget (£25.7bn by 2029-30).
Minimum wage
National Living Wage for 21+ to go up by 6.7% from £11.44 per hour to £12.21 per hour from April 2025.
National Minimum Wage rates for younger workers will also increase from April 2025 – for 18-20 year olds, the increase will be 16.3% to £10.00 per hour.
The two will be aligned over time to form a single adult wage rate.
These changes will in turn increase employer and employee pension contributions where earnings are based on minimum rates.
State pension
The State Pension Triple Lock will be maintained for the rest of this Parliament. The state pension will increase by 4.1% in 2025-26. This means the full State Pension will increase to £230.25 per week (from £221.20).
European Economic Area (EEA) Overseas Pension Schemes (OPS)
OPS and Recognised OPS established in the EEA will be aligned with those in the rest of the world from 6 April 2025. HMRC’s Newsletter 164 provides further details of these changes and also the removal of the overseas transfer charge exclusion that applied to members transferring to a Qualifying Recognised OPS in the EEA or Gibraltar.
Scheme administrators
Scheme administrators of registered pension schemes will have to be UK resident from 6 April 2026.
Mineworkers’ Pension Scheme
The current Investment Reserve Fund will be passed to the trustees, and this will be provided to members as pension. Surplus sharing arrangements will also be reviewed.