by  Sarah Lister, Partner, Probate and Kyle Barford, Senior Tax & Trust Manager.

Pension funds have long enjoyed a favourable status for UK inheritance tax (IHT). Most registered pension schemes are discretionary and outside the scope of UK IHT.

This has traditionally made pensions a very efficient way of passing wealth to chosen beneficiaries who are not exempt from IHT, such as children. However, from 6 April 2027, any remaining funds within a pension on an individual’s death will form part of the deceased individual’s estate for IHT purposes.

General IHT position

For IHT purposes, whether an individual is a long term UK resident (LTR) or a non-long term UK resident (non-LTR) will have a significant impact on the deceased’s UK IHT position.

Very generally, an individual will be considered as an LTR if they have spent 10 of the last 20 tax years as a UK resident. The 10 years do not need to be consecutive. The test for the UK residence is the statutory residence test (as for UK income tax). Note also that, depending on how long an individual lived in the UK, there is a “tail” which ensures that their worldwide assets remain within the UK IHT net for some years after they stop living in the UK. That is outside the scope of this article, but former UK residents should take advice as they may unwittingly still be within the UK IHT regime. Tax payers should be particularly cautious about any tax years where split-year treatment applies or where they are claiming treaty non-residence in the UK as such years count as full years of UK residence for LTR purposes.

The likely new process

The pension fund will aggregate with an individual’s estate for IHT purposes, as well as with any interests the deceased had in certain types of trust, which are outside the scope of this article. The allowances and subsequent tax liability will then be pro-rated against the various elements of the estate.

HMRC released a technical note on 11 May starting to give more detail on the process and obligations of both Personal Representatives (PRs) and Pension Scheme Administrators (PSAs) to ascertain the pension values and pay IHT. Further information is expected although HMRC’s anticipated release date for some of this information is as late as Spring 2027 – not a particularly encouraging timeframe when the new rules are fully effective from 6 April 2027!

Under the proposed rules, PRs would request a pension valuation and beneficiary details from the PSA following a member’s death. The PSA must provide the valuation and beneficiary information within set timescales, and where IHT is anticipated, PRs can require the PSA to retain part of the pension fund (up to 50%) and make inheritance tax payments, with the withholding arrangement lasting for up to 15 months from death. Importantly, there does not appear to be any timeframe for the trustees of the pension fund to determine the beneficiaries of the fund; the proposed statutory deadlines relate only to the sharing of information before and after that determination has been made.

The payment date of IHT currently remains unchanged - interest of 4% above Bank of England base rate will start to accrue on any unpaid tax from the end of the sixth month after death. It is widely agreed that completing the process above is going to take considerably longer than six months. However, HMRC is currently standing strong on this point. Early action is going to be key to achieving this timeframe.

Consultations are currently ongoing in relation to information sharing between PRs and PSAs and further guidance on the more technical points is anticipated.

For UK LTRs with pension funds abroad

For LTRs, their worldwide estate will be subject to UK IHT, including assets in pension funds and SIPPs in the UK and property held in qualifying non-UK pension schemes (QNUPS) and s615(3) schemes. These rules applying to QNUPS will also apply to Qualifying Recognised Overseas Pension Schemes (QROPS).

The requirements to issue withholding or payment notices do not apply to the administrators of a QNUPS which is not surprising as HMRC has limited options to compel overseas administrators to engage with arranging to settle a UK IHT liability on the QNUPS fund directly from that fund. This leaves three options in practice:

The liability is met from the assets of free estate. To allow the PRs to do this in a timely way, it would be sensible to plan for any assets earmarked for this purpose to be easily administered and liquidated within 6 months of death, so having up to date Wills in place would be essential. If the beneficiaries of the QNUPS and the free estate are different then it may be necessary for the taxpayer to revisit how they would like their free estate to be distributed and updating any relevant letter(s) of wishes

The liability is met by the beneficiary of the QNUPS. To raise the necessary liquid funds the beneficiary may need to receive a distribution from the QNUPS. Whilst such a distribution would not be charged to UK income tax in the hands of the beneficiary, this is likely to raise considerations for the beneficiary in their jurisdiction of residence. A gross distribution from the QNUPS to meet both the UK IHT liability and settle any personal liability of the beneficiary could be significantly higher than the UK IHT liability alone

An insurance policy is put in place to cover the liability.

If inheritance or estate tax is payable in another jurisdiction as well as the UK, the executors of an individual’s estate will need to look at appropriate double tax treaties or unilateral relief to mitigate the potential impact of double taxation.

Early planning and timely communication between PSAs, PRs and pension beneficiaries will be key. LTRs should ensure there is a complete list of pension funds available to their PRs on their death, to include any pension funds held internationally. Where an LTR has made specific investments or taken out insurance to meet the UK IHT due, they should retain a note of their planning alongside or as part of their letter of wishes. Later discovery of pensions will cause real difficulties for PRs and beneficiaries and unnecessary interest charges will likely apply.

As with domestic UK pensions LTRs should give careful consideration as to who they wish to nominate as the beneficiary of their QNUPS and ensure that this nomination is kept current and up to date with the administrator. As the nomination is not generally binding on the pension trustees, it is worth understanding the factors that the pension trustees will take into account when exercising their discretion over who benefits from the fund after death.

LTRs who have taken no or minimal withdrawals from their pension whilst resident in the UK for income tax reasons may wish to consider reviewing their nomination when they turn 75. Before this date the QNUPS beneficiaries will generally receive distributions free of UK income tax even whilst UK resident, but after this date any UK resident beneficiaries would be charged income tax on distributions at their marginal rate.

For non-LTRs but with UK pension funds

For non-LTRs, in general only the individual’s UK situs assets will be subject to UK IHT. Assets held in another jurisdiction would be considered as ‘excluded property’ and outside the scope of IHT. However, as the UK SIPP or pension fund would be a UK situs asset, it would remain within the scope of IHT.

QROPS are also within the scope of IHT even though they are administered abroad so the transfer of a UK pension to a QROPS is ineffective for UK IHT mitigation purposes.

For a non-LTR whose only UK asset is a UK pension, retaining residence information is crucial. Whilst a non-LTR may not have an English will, or need to appoint English PRs, someone will need to take on the role of completing an IHT return for the estate. It is not clear who that person will be yet, although most likely a pension beneficiary or a person entrusted in the country of the deceased’s residence if there is no UK Will. To claim non-LTR status, 20 years of residence status will need to be declared. Whilst in many cases this will be straightforward, with increasingly internationally mobile clients, for many it will be not quite so easy.

The UK’s statutory residence test only came into effect in April 2013 so to assess UK residence over the past 20 years it will be necessary to consider the pre-April 2013 rules for those tax years which were heavily case law based rather than codified in statute.

Pension income paid from the UK is generally subject to UK tax at source (PAYE) but there may be an opportunity for tax relief for recipients who live outside of the UK. Under the OECD model treaty the pensions article will generally award the primary right to charge income tax on a pension to the State in which the recipient of the income is resident, though there are common and notable exceptions for Government pensions and lump sum payments.

This means that, where the recipient is resident in a jurisdiction which has a Double Taxation Agreement with the UK, the recipient is often able to lodge a form DT-Individual with HMRC to apply for relief at source to stop UK withholding tax.

Planning opportunities

It is crucial for any taxpayer who considers themselves non-LTR in the UK and where their non-LTR status is material to their potential UK IHT liability to take professional advice on their UK residence position under domestic UK law and to keep clear records regarding this

All UK LTR individuals with a pension in or outside of the UK, as well as individuals who are not LTR but who hold a UK pension asset, should ensure that their Wills, expressions of wishes, and pension beneficiary nominations are regularly reviewed and updated

Where pensions are not simply passing to a spouse outright steps should be taken to understand the information which will be considered by the pension trustees when they exercise their discretion

Consideration should be given as to how and when the IHT liability for a pension will be met to avoid interest charges. Care should be taken not only to ensure sufficient liquid funds, but to put the necessary paperwork in place to obtain probate and release those funds. Insurance may provide an alternative option particularly for illiquid pensions such as a SSAS invested in commercial property

If a pension IHT liability can be met from funds outside of a pension such as free estate assets or via an insurance policy, then more assets can be kept within the pension. Pensions allow for UK tax-free roll-up of income and gains in the hands of the beneficiary as well as the original owner so can be a very tax-efficient vehicle for multi-generational planning

Pension funds are not subject to IHT loss relief so illiquid pension funds which are forced to sell assets at a loss to meet an IHT liability will not receive UK IHT relief for that loss

QNUPS beneficiaries meeting a UK IHT charge directly may lead to additional tax charges personally depending on their other circumstances

The most tax efficient planning for a UK pension or QROPS will always depend on individual facts and circumstances. Despite the April 2027 changes pensions remain a highly effective UK tax planning tool, but any previous advice should be revisited in light of the changes to ensure that taxpayers are making the most of the tax savings available.