Tax on multiple pension pots will create admin chaos

Sara White, Editor, Business & Accountancy Daily. Croner.

Massive overhaul of inheritance tax on pension assets will be difficult for executors to manage with HMRC’s lack of flexibility on short six-month IHT payment deadline.

Pension savers need to consolidate scattered pension pots into one place to prevent an admin nightmare for their families after new inheritance tax (IHT) rules come in next April, warn experts at Evelyn Partners. Even if pots are not consolidated, it is vital that pension holders keep records of all their disparate pots to prevent meltdown for estates.

The pension pot tax will see personal representatives (PRs) - the executor where this a will, administrator where there is no will or it is invalidated, and solicitors appointed by families - responsible for paying tax on the pension assets at 40% IHT rate.

From 6 April 2027, unused money-purchase pension pots will be included in estates for the calculation of IHT and this is already having consequences.

Already Evelyn Partners has seen many pension savers deciding to take their tax-free lump sum or draw down more heavily on their pension pots in order to spend or gift, or in some cases buy annuities, so that they are not leaving a surplus pot that will be taxed at 40% at death.

Worse still, the pot could be double-taxed if someone dies at age 75 or over, as a beneficiary may also pay income tax on the inherited pension fund at their marginal rate.

Andrew King, pensions technical specialist at Evelyn Partners, said: ‘Pension consolidation can be a good move for a number of reasons, but the inclusion of unused pension pots in IHT liabilities will add extra urgency for many families.

‘This is because having several, scattered defined contribution pension pots could land their personal representatives with a real admin headache, interest charges from HMRC and potentially a lot of stress.’

One of the biggest concerns is the government’s refusal to extend the IHT payment deadline beyond the standard six-month window. IHT will remain due from the personal representative (PR) at the end of the sixth month after the date of death.

Complexity will arise as people with multiple small pension pots could have flimsy records and the likelihood family members or executors would be able to identify the pension assets quickly is a major concern.

King said: ‘The way the rules have been drawn up for IHT from next April, the PR will have to go to each pension provider and try to access funds within the six-month deadline from death for the payment of IHT.

‘Where there are several pension pots with different providers, this could not only prove a heavy administrative burden but also potentially hit the estate with interest charges.

‘Many older pension providers have been acquired by consolidater-firms, and this can lead to slow response times. So many estates and beneficiaries are going to face late interest payments at the rate of 4% above the bank rate (which currently makes interest due at 7.75%) if they miss the IHT deadline due to administrative logjams.’

HMRC has not released detailed guidance on the new pension pot rules yet, creating even more confusion and this is now urgently required with less than a year until the new legislation comes into effect.

It appears that the government may offer some respite for estates, with indications it will allow pension providers to put a temporary stop on paying out 50% of the money from a pension for up to 15 months. However, interest will be charged from the sixth month.

King added: ‘While interest will still be charged from the sixth month, this does allow some breathing space for a complex estate to be sorted – for instance where the pension contains illiquid assets such as property or private company shares.

‘The time should allow liquidity to be created to pay the tax, and it means that the 40% IHT liability for a pension is totally covered by the 50% being withheld. But it is also essentially a tacit admission on the part of the authorities that the winding up of pension assets could take a lot longer than the allotted six months to pay the IHT bill.

‘It really is disappointing that the government did not see fit to extend the IHT deadline to mitigate all of this.’

From a practical point of view, families and accountants need to make sure their relations and clients have all their documents in order, either online or physically stored. This will help the probate process and be invaluable to executors, hopefully reducing costs and the stress of the bereavement.

Caroline Foulger, partner at Hunters Law LLP, said: ‘The key to being a good executor is to be organised. However, that is often dictated by how organised the testator was.

‘It is always useful for a testator to make sure their executors know where important documentation is. Furthermore, diligent record keeping regarding their estate and finances can be a good cost and time-saving tool to ease the administrative burden on the executors.

‘All of the documents should be physically stored in an accessible place where the executors will easily find them or know where to look. Alternatively, an electronic filing system that the executors know how to navigate may be preferable for copies of documents.’