Aligning inheritance tax with pensions: A call for pragmatism

The UK Government's recent consultation on applying inheritance tax (IHT) to pensions aims to address the perception that pension savings are being used as a vehicle for wealth preservation rather than retirement income. 

While we understand the Government's desire to ensure pensions serve their intended purpose, their proposal to allocate the Nil-Rate Band (NRB) on a strict formulaic basis will grind to a halt the process of settling death benefits – from estates and pensions – and bring about adjustments after the event that will impact all parties.

The proposed framework relies heavily on the estate and all relevant pension arrangements being valued swiftly and in unison so that the Personal Representatives (PRs) of the deceased can apply a formulaic allocation of the NRB.

It only takes one valuation to be delayed to cause the whole process of allocating the NRB to grind to a halt while the last piece of information is collated.

The alternative is to make a 'best guess' but when the actual valuation is known, the NRB for the estate and all pension arrangements would then need to be re-allocated with all the tax bills recalculated with some going up and some going down.

The same is true if the valuations are all obtained and the NRB allocated based on up-to-date information ... but then some information changes and the adjustments have to be made again. And then if a second piece of information changes, another adjustment has to be made.

Sadly, one such item of information that might change could be the destination of the death benefits. A pension scheme administrator might report that the surviving spouse is to benefit, but by the time it comes to settle benefits having gone through the information exchange with the PR, the surviving spouse is no longer able to benefit, leading to surviving nominees to benefit instead and a complete rework of the NRB allocation.

"The formulaic allocation works in the theoretical world but has no place in the real world."

To escape these issues, if there is insistence that integrating pensions with IHT and the NRB is the way the policy principles must be met (there are plenty of other ways, that will also seek to tax benefits without such complications) then realistically the NRB will have to be allocated once – and once only – by the PR. They may have recourse to instructions via the will or a letter from the recently departed, but by having the responsibility of allocating the NRB it will allow the estate and each relevant pension arrangement to get on with settling death benefits without having to wait for the slowest party or worry about the NRB allocation being altered just as they are about to pay out the benefits, or after they have done so.

Of course, moving away from a formulaic approach presents 'planning opportunities' and the potential for some arbitraging. But I fear legislation becomes too complex without regard for the practical consequences all in the name of trying to stop some people trying to use the rules in the most advantageous way possible. That isn't the big issue here. The issue at hand should be: if we are going to shake up the pensions landscape by integrating it with IHT, how can we achieve that it the least disruptive way possible? That would be far less costly for consumers and likely the Government as well.  

Does it really matter if someone says they want to split the NRB equally between their estate and their pension, when the formulaic approach might suggest 44.37%:55.63% ? And does it matter that much if instead they say they want it 100% attributable to their estate (or pension)? No, not really. But it cuts out a whole heap of issues highlighted in the consultation paper about delays and adjustments.