As we near the end of the year and look forward to 2025, it’s difficult not to reflect on the year to date. 2024 presented new challenges for the pension industry, most notably in respect of the implementation of the lifetime allowance abolishment and more recently, the announcement that from 2027, ‘unused’ pension benefits will be subject to inheritance tax.
Indeed, it almost seems unfair that in the same year, individuals have been given freedom to save above the old LTA limits, only for the new Government to pull the rug from under them and put unused pensions within IHT scope.
With both of these developments, it is the SSAS and bespoke SIPP market which bear the brunt, having higher proportions of clients fitting the categories of membership most effected.
The challenge the industry now faces is trying to meet the expectation of clients, who, armed with a headline, expect a solution while we as the pension professionals, have as many questions as our clients!
I suspect we are around 12 months away from primary legislation and based on past experience, if the lifetime allowance abolishment rules are anything to go by, I worry that we will not get everything that we need to answer client queries and plan, correctly drafted first time.
The Chancellor’s IHT proposals cannot work alongside the current process, as scheme trustees have two years to assess and designate death benefits, taking into account Expression of Wish letters, client Wills and any other evidence they may need to determine to whom benefits will be distributable. Only once this work is concluded, can Scheme Administrators clarify what, if any benefits, for example if partly to a spouse and partly not, would fall into the calculation for IHT purposes.
Meanwhile, the current proposed system would see this concluded with tax paid within 6 months of death.
Similarly, as many SSAS and SIPP clients have utilised their pension to acquire a commercial property, which presents great tax advantages, it is going to be difficult to value the property, arrange a sale, realise the sales proceeds, and pay IHT within the 6-month period that the Government is suggesting.
The pension assets are also to be valued on death, meaning that any subsequent sale of the property under that value will detrimentally impact the beneficiary. These are the types of issues that need to be carefully considered, along with industry feedback via the ongoing consultation before rules come into effect in 28 months’ time. It is this type of issue that might persuade advisers to favour SSAS over SIPP given the sheer practicalities of property disposal (in a SIPP) while in a SSAS the property remains an asset of the trust.
The purpose of the proposed changes is also far from certain. While the Government intention is clear, perhaps applying a tapered rate of IHT on pensions might be more suitable, with higher value estates being charged more than smaller estates, that may have just tipped over the threshold for IHT being payable.
IHT thresholds are frozen until 2030, meaning more and more people are going to be dragged into paying it.
It’s reasonable to assume that increased property prices are going to play a significant part in terms of people being tipped into paying IHT. There is also the risk of double taxation for those beneficiaries above the nil rate tax band. IHT would be payable at 40% and then income tax payable for the beneficiary at their income tax rate when funds are drawn from the inherited pension. Therefore, a higher rate taxpayer is going to pay an effective rate of around 64% tax on monies inherited from the pension. In extreme circumstances, it is reported that total tax take could rise to near 90%.
Looking at how much the Government stands to increase its tax coffers by implementing these changes, it understandably isn’t sitting well with many in the industry that such a significant change is being made. IHT obviously presents a reliable source of tax revenue for the Treasury.
Between 4% and 5% of all deaths currently result in an IHT liability. The addition of pensions into the scope of IHT is clearly going to increase that figure and it is disappointing that the Budget did not give an indication of how much it might rise. For those that have sacrificed to save into their pension, not anticipating that IHT would be due, this is going to be a difficult pill to swallow.
People have planned for decades on the basis of IHT not being payable on pensions, predicating their long-term strategies on the basis of the current rules. They are suddenly finding themselves in a position that cannot easily be unwound.
IHT rules can be complicated enough without bringing in pensions. Recent analysis has shown that investigations by HMRC on IHT has generated an additional £285m in the tax year ending March 2024. This is despite a reduction of 14% in the number of investigations undertaken. We of course need to appreciate that some of these investigations could be as a result of tax evasion, but there’s little doubt that the IHT rules are going to be more complicated when the new rules are implemented in 2027.
But it’s not all doom and gloom. These significant rule changes highlight the growing importance of seeking expert tax advice and skilled scheme administration. Clients should exercise caution, as the possible emergence of new IHT 'schemes' claiming to offer solutions could pose serious risks in the long term. It is essential for the entire pensions profession to uphold the highest levels of integrity and technical expertise.
Martin Tilley is chief operations officer at WBR Group