Charlene Young: IHT changes for simple estates don't go far enough

One change announced by the Treasury on “Tax Day” was an aim to reduce the amount of red tape surrounding inheritance tax (IHT).

Whilst any effort to reduce form filling and wider administrative burdens are welcome, the changes do nothing to address confusion over the treatment of pensions in relation to IHT.

The government has said it will simplify the IHT reporting regulations from 1 January 2022, meaning that more than 90% of non-taxpaying estates will no longer have to complete an inheritance tax return to obtain probate.

It is estimated that 200,000 estates will no longer need to report and although we haven’t received full details of the new rules yet, it seems likely that these estates will be those where all assets pass to a surviving spouse or civil partner, along with those estates with assets below the nil rate band of £325,000.

What has this got to do with pensions?

The announced changes stem from recommendations made in reports by the Office for Tax Simplification (OTS) back in 2019. The second of these reports also acknowledged the complex interaction between IHT and pensions.

Most day-to-day pension activities are exempt from or not chargeable to IHT. However, death benefits subject to a binding nomination, and transfers and contributions where the member had a severely reduced life expectancy, could be chargeable.

Executors, and advisers, are not always aware that certain pension events in a client’s lifetime should be reported on IHT409 forms on death as they might use part of the nil rate band. The new rules could lead to further underreporting as more estates believe they have no forms to complete at all.

In defined contribution schemes where a member effectively has their own pension pot, most providers will exercise their discretion when deciding who should receive pension death benefits. This means the funds are generally out of scope for IHT as, although a client can complete a nomination, the provider is not bound by it.

However, the time and cost burden of properly exercising discretion purely to meet this requirement can add costs to even the simplest of cases. Not quite in the spirit of simplification and reducing the confusion and burden for taxpayers on whom the costs ultimately fall.

Even where a provider feels they have spent due care and attention to properly consider the situation and exercise their discretion, they might find one or more parties are unhappy with the decision and challenge it further. This leads to additional delays and costs to resolve the situation – with the resolution potentially ending up with the same decision.

Our experience shows that the number of people making transfers or increasing contributions in the two years before their death is very low compared to the general level of contribution and transfer activity.

Yet the time and legal costs for both sides when claims on transfers are pursued must be relatively high. Consider the Staveley case (HMRC v Parry and Ors) which went all the way to the Supreme Court for a final judgement over 13 years after the member’s death.

The simplest solution would be for government to removed pensions and death benefits from the scope of IHT completely. This would reduce the costs and administration time for most cases and simplify matters for clients, and their beneficiaries, with little or no loss of revenue to HMRC.

It would also mean that the court cases and claims such as that of Mrs Staveley would no longer need to be heard.

Charlene Young is senior technical consultant at AJ Bell