The Chancellor's Autumn 2024 Budget (the Budget) this year introduced several changes affecting the pensions landscape in the UK, most notably in the areas of pensions taxation. While the anticipated large-scale reforms did not fully materialise, some significant adjustments were made, namely extending the range of pensions death benefits that will become subject to Inheritance Tax (IHT) on a member's death. The Budget also removed the exemption from the Overseas Transfer Charge (OTC) for transfers to Qualifying Recognised Overseas Pension Schemes (QROPS) established in the European Economic Area (EEA) and Gibraltar, meaning these transfers will now incur a 25% charge unless specific residency conditions are met.

These changes, which are due to be introduced in April 2027, have important implications for members, trustees and employers involved in pension schemes, which we explore below.

What are the key changes?

Inheritance tax on pension death benefits

From April 2027, "unspent" pension pots and death benefits within registered pension arrangements will form part of a person's estate for IHT purposes. This change aligns with the government's policy to put an end to the practice of using pensions to mitigate IHT liabilities. The new rules will apply to defined contribution (DC) arrangements and to lump sums payable on death from defined benefit (DB) arrangements. Both will form part of a deceased member's estate for IHT purposes. The government anticipates that these changes will result in approximately 10,500 more estates becoming liable for IHT than would otherwise have been the case, raising £1.46 billion a year by April 2030.

Dependants' scheme pensions will remain outside the IHT net, but unused drawdown funds and most lump sum death benefits will now be included. This means that these funds will be subject to IHT unless they fall within the nil-rate band or are passed to a spouse or civil partner, where an exemption from IHT applies.

For individuals, the inclusion of pension funds in the IHT estate could affect overall estate planning strategies, particularly where large pension pots are involved. This change may also impact the availability of the residence nil-rate band, leading to higher effective tax rates on estates exceeding £2 million. Additionally, there is potential for double taxation when a lump sum is paid for a member who dies after age 75 because these funds may be subject to IHT as part of the estate and also incur income tax when withdrawn by beneficiaries. This could result in a significant tax burden, further complicating the financial implications of inheriting pension assets.

The government is currently consulting on these proposals, with the consultation open until 22 January 2025. A further consultation on draft legislation is expected later in 2025. This process aims to refine the implementation details and address potential complexities, such as the interaction with existing tax allowances such as the residence nil-rate band.

Overseas Transfer Charge adjustments

Effective 30 October 2024, the exclusion from the OTC for transfers to QROPS within the EEA or Gibraltar has been removed. This change aims to prevent the exploitation of double tax-free allowances, which previously allowed individuals to transfer UK pension savings to these regions without incurring the usual 25% charge. Historically, the exclusion was designed to align with European Union freedom of movement principles, enabling pension transfers without immediate tax consequences. However, this allowed individuals to benefit from UK tax relief while residing abroad, potentially depleting UK tax revenues. The government projects that this measure will safeguard approximately £1 billion of UK tax-relieved pension savings from being transferred overseas without due taxation.

For individuals considering relocation to the EEA or Gibraltar, the financial calculation of pension transfers will become more complex. They will now need to ensure that their QROPS is located in the same country as their residency to avoid the 25% charge, limiting flexibility in choosing pension schemes based on financial performance or service offerings.

Some businesses administering pension schemes could face significant challenges due to the removal of the OTC exclusion. If a scheme loses its status as a QROPS due to non-compliance with new requirements, it would lose its capital gains tax exemption on investment disposals and incur unauthorised payment charges on transfers. This loss of status would also prevent the scheme from receiving recognised transfers, potentially reducing its attractiveness to new members and contributions.

Financial advisers will need to reassess the advice provided to clients regarding overseas pension transfers. The removal of the exclusion may lead to an increased demand for alternative pension products, such as International SIPPs, which may offer more favourable tax treatment.

Some considerations for employers and trustees

• Increased role of scheme administrators: From 6 April 2026, registered pension schemes will be required to have a UK resident scheme administrator. With the introduction of IHT on certain pension death benefits, scheme administrators will play a crucial role in managing these liabilities. They will need to work alongside trustees to ensure the accurate reporting of relevant death benefits to HMRC and the payment of any IHT due. This will involve updating administrative processes and coordinating with personal representatives, since administrators will need to apply a proportion of the nil-rate band to pension benefits, as well as the spouse/civil partner exemption where appropriate. Similarly, administrators must ensure compliance with new regulations regarding overseas pension transfers.
• Review of death benefit arrangements: Given the changes to IHT, trustees and employers will need to review the structure of death benefit arrangements to ensure they align with the new tax implications and optimise tax efficiency for beneficiaries. It is likely that trustees will need to communicate the changes to members too, once the details of the new regime have become clearer and their own scheme's position on the changes has been settled. Also, it is worth noting that, currently, HMRC applies interest on the late payment of IHT from six months after the date of death. Unless this changes, trustees will need to make and implement their decisions on death benefits over a much shorter time period than they are accustomed to.

If you would like to discuss anything arising out of this article, please feel free to reach out to the authors or your usual Dentons contact.