Advisers say this rule may go under the radar and surprise a lot of families
There is a little known detail in the new inheritance tax rules that experts have said could be a “significant issue” for grieving families.will form part of an estate when inheritance tax is calculated.threshold but for those with large pension pots in combination with other assets, this rule may pull them into paying the tax for the first time.
And earlier this month, HMRC revealed that pension schemes will be able to withhold 50 per cent of a deceased person’s pension pot until the amount of IHT owed is calculated – something known as a withholding notice. Experts have said a lot of families may not know about this rule prior to a death but will be relying on the money to cover things like funeral costs or other everyday expenses like mortgage payments.
HMRC has said the rule would only affect a small number of cases but Andrew Tully, technical services director at financial platform Nucleus warned the rule could become “standard”. If on death your estate is worth more than the £325,000 tax-free allowance – the nil-rate band – anything above this threshold will be subject to IHT, charged at 40 per cent.and a direct descendant inherits it, your tax-free allowance will be £500,000 because of the £175,000 residence nil-rate band.
Married couples can get a combined allowance of up to £1m but if your estate exceeds this, there could be tax to pay. The £175,000 extra allowance for your home only applies if the estate is worth less than £2m. On estates worth more than this, the allowance will decrease by £1 for every £2 above £2m that the estate is worth.
The withholding notice means that, from April 2027, pension firms can withhold 50 per cent of a deceased person’s pension pot until the amount of IHT owed is worked out or up to 15 months after the date of death. Tully said many pension schemes may face a “significant issue” when telling beneficiaries – someone receiving the inheritance – that despite them identifying someone as a recipient of the money, they can only give them some of the inheritance now.
Once the personal representative – someone responsible for reporting and paying any IHT due on an estate before its distribution – has worked out the IHT due from the pension, they then ask the pension scheme to pay that direct to HMRC from the withheld 50 per cent with the remainder to be paid to the beneficiary. This could create issues for the representative, likely a family member, who risks the upset and anger of those receiving the inheritance.
Tully said: “If some or all pension benefits are going to an unmarried partner or children – and especially if the pension beneficiaries are different to the beneficiaries of the wider estate – the executor of the will will want to make sure the pension beneficiaries pay their fair share of the IHT. ” Additionally, if all of someone’s pension is paid to the beneficiary and they refuse to pay IHT, the personal representative has to pay HMRC out of their own pocket and recover the money from the beneficiary, potentially by taking legal action – something that is time consuming and can come with large costs.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “It’s a real balancing act in that being able to put a hold on part of the pension can really help the personal representatives to prepare for any potential IHT bill that may land and they can only request the hold if they have a reasonable view that IHT will be payable.
“However, it may come as a surprise to beneficiaries who may be expecting to receive a certain amount and it might cause them difficulties if they have to wait. Good communication is vital between beneficiaries and personal representatives. ”Katherine Waller, co-founder of advice firm Six Degrees said the issue with this rule will be more about the timing than having to pay the tax itself.
She said: “Families in the immediate aftermath of a bereavement may rely on pension assets to cover urgent costs – funeral expenses, probate, bridging everyday bills while the estate is settled. A 15-month hold on half that pot is a cash flow crisis dressed up as a tax change.
” Some of the approaches Six Degrees have been taking with clients include keeping a separate pot of cash in a joint account with an child, so that they have access as and when needed. They added they advised to use life insurance tactically, to cover either the IHT bill itself, or to provide beneficiaries with immediate money over and above the amount required for tax.
Writing the policy into trust, which ensures that the payout is not included in the deceased’s estate, is also an option. Mike Winstanley, director of wealth management at Bentley Reid, described the withholding rule as a “pretty significant development”. One approach he is taking with clients is lifetime gifting as it reduces the taxable estate over time.
You can give away a total of £3,000 worth of gifts each tax year without them being added to the value of your estate – this is called your annual exemption. You can carry any unused annual exemption forward to the next tax year – but only for one year. Winstanley said: “It means children and beneficiaries have their own accessible funds and are not left waiting on the pension being released at what is already a very difficult time.
“There is also something to be said for the fact that it allows people to see their loved ones benefit from and enjoy those funds during their lifetime, which for many families is just as important as the tax planning itself. ” Eamonn Prendergast, director of Palantir financial planning said it would be an issue for single, widowed, divorced, or unmarried clients, especially where benefits are passing to children, family members, or an unmarried partner.
“That includes reviewing expression of wish forms, making sure pension records are clear, ensuring executors know where pensions are held, checking wills, considering whether there is enough accessible cash outside pensions, and looking at whether life cover or trust planning may be appropriate to provide liquidity. ” A spokesperson for HMRC said: “More than 90 per cent of estates will still pay no inheritance tax, including on pension funds.
We do not want payments to pension beneficiaries delayed unnecessarily, and personal representatives will only be able to delay payments where they have a reasonable expectation that inheritance tax may be due. ”
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