As the government attempts to reform pensions, the complexity of the system continues to pose challenges. The latest focus is on the application of inheritance tax (IHT) on pensions, a measure announced in last year’s autumn Budget. The intention behind this move is to ensure that pensions are primarily used for retirement savings rather than as a tool for IHT planning. However, the practical implications of this change are proving to be quite daunting.

Recently, the chief executives of major financial firms such as AJ Bell, Hargreaves Lansdown, Interactive Investor, and Quilter penned a joint letter to Chancellor Rachel Reeves expressing their concerns about the proposed IHT changes. They highlighted that the complexity of the new approach could lead to significant delays in distributing funds to beneficiaries upon the death of the pension holder, causing distress for bereaved families.

Experts have also raised alarms about the bureaucratic nightmare that could unfold for families due to these changes. Pension providers may face challenges in determining the amount to pay out to beneficiaries versus the amount owed to HMRC upon the pension holder’s death. Delays could occur in cases where no IHT is due on the estate after all information has been gathered.

The letter also pointed out a concerning trend in probate requests taking longer to be granted, with a 134% increase in cases exceeding a year between 2020 and 2023. Delays in probate approval can hinder access to the deceased’s assets, including pensions, leading to financial hardships for families. The need to sell illiquid assets within pension schemes to settle IHT obligations could further exacerbate delays.

One particularly alarming scenario outlined in the letter is the potential for some families to face a marginal tax rate of up to 90% on inherited pensions. This extreme tax burden would apply to estates exceeding £2 million that include pensions of individuals who pass away after the age of 75. The combination of IHT at 40%, tapering of the residence nil-rate band, and income tax on pension withdrawals could result in exorbitant tax liabilities for beneficiaries.

While the government’s aim to rationalize the use of pensions for retirement savings is commendable, the current execution of the IHT changes raises significant concerns. The Treasury has set a timeline for these reforms to take effect in April 2027, allowing ample time for refinements to address the challenges highlighted by industry experts. It is evident that a more streamlined approach is necessary to prevent undue financial burdens on families and ensure the effective utilization of pension funds.