Following the new UK Government’s first budget in October, we have outlined the main changes to pensions and discussed the impacts these changes will have on members and beneficiaries of both UK and non-UK pension schemes.
UK Budget Pension Changes
The two main changes announced in the UK Autumn 2024 Budget were:
1. UK Inheritance Tax (IHT) on pension funds
2. Removal of the concept of ‘domicile’, replacing it with a residency-based test for UK IHT purposes
1. UK IHT on pension funds
Currently, any member’s remaining pension fund on death is paid to beneficiaries free of UK IHT, meaning it does not form part of the taxable estate of the deceased member. As of April 2027, this will be rescinded, and the majority of payments from a pension fund following the death of the member will now be subject to UK IHT at a rate of 40%.
HMRC have issued a detailed list of the payments from a pension scheme that will be included in the estate of a deceased member. (See: https://www.gov.uk/government/consultations/inheritance-tax-on-pensions-liability-reporting-and-payment/technical-consultation-inheritance-tax-on-pensions-liability-reporting-and-payment).
While this change relates to UK pension funds, it has also been extended to include non-UK pensions that previously were exempt from UK IHT on death under QNUPS regulations. This means that QNUPS (and by extension QROPS) will now also be within scope for UK IHT. Therefore, someone who is liable for UK IHT on their worldwide assets will, from April 2027, have any UK or non-UK pension funds included in their estate for IHT purposes. (For clarity, non-UK pensions that do not qualify as a QNUPS have always been included in the estate for UK IHT).
To add to the IHT charge, benefit payments are in some cases also subject to tax in the hands of the beneficiary. Under current rules, payments on death before age 75 (where the deceased member still holds sufficient lump sum death benefit allowance) are free of income tax in the hands of the UK resident recipient, but payments on death post age 75 are taxable as income.
This effectively means that, for an individual in scope of UK IHT on death, in the scenario where nil rate thresholds and other reliefs on an individual’s estate have already been utilised and therefore the full value of the remaining pension fund is subject to UK IHT, a £1,000,000 pension fund would incur 40% IHT, and the balance (£600,000) taxed as income at up to 45% on receipt by the UK resident beneficiary, meaning a net receipt of £330,000, an effective tax rate of 67%.
2. Removal of the concept of ‘domicile’, replacing it with a residency-based test for UK IHT purposes
It is proposed that the concept of domicile is replaced with a new non-residency status rule. Under this new rule, to be classed as a non-UK resident for IHT purposes, an individual would be required to have lived outside the UK for at least ten of the last 20 years.
Considerations for Non-UK Residents
If someone meets the new non-residency status rule, then they should only be liable to IHT on their UK situs assets. Consequently, if a transfer to a local pension in their country of residence is possible then this could be considered to effectively reduce their UK assets and consequently reduce their potential UK IHT liability.
Considerations for UK Residents
Historically, in the knowledge that their pension fund has been outside of the scope of IHT, some individuals with sufficient wealth to not have to rely on their pension pots, have intentionally left their pension fund untouched to pass on to their beneficiaries. With the scope of IHT changing, perhaps taking benefits, including the lump sum, will be more popular moving forward, with this money being passed on as a gift and thereby reducing the taxable value of the estate for IHT purposes.
For married couples and those in civil partnerships, it is important to remember that the spousal exemption still remains. So, if funds are passed to the spouse, IHT won’t be paid until after the second death. This may be useful in the event that a couple are outside the UK and the spouse survives past the 10-year exemption rule.
A Question
As the new rules states that a member will be non-UK resident for IHT if they have lived outside the UK for more than ten years of the last 20, does this imply that if a member has been outside for 20 years and returns to the UK, they will still be outside the net for IHT for 9 years and 364 days? An unanswered question for the time being.
Considerations for Pension Trustees
Administration
The potential double tax obligations of IHT and income tax (on the beneficiary) mentioned above, may cause a headache for executors dealing with estates. A proposed solution to ensure tax obligations are addressed is that the pension scheme administrators (PSAs) will become liable for reporting and paying any IHT due on unused pension funds and death benefits. PSAs are currently being consulted on this and the consultation will run until 22nd January 2025. (See: https://www.gov.uk/government/consultations/inheritance-tax-on-pensions-liability-reporting-and-payment/technical-consultation-inheritance-tax-on-pensions-liability-reporting-and-payment)
The question for non-UK PSAs is how they will be involved in the reporting and payment of IHT. For example, how will the non-UK PSA know whether or not a member is classed as non-UK resident or not? What will the penalties be if they do not deduct tax when they should? This challenge will be exemplified for deferred members, as the PSA will be even less likely to understand the member’s full circumstances.
This requirement, should it go ahead, will also fall on personal pension scheme administrators outside the UK where the deceased member fails the new non-UK resident test for IHT purposes on death. It is proposed that further guidance as to how this will apply to non-UK pension schemes and the requirements for their respective administrators will follow at a later date.
Pension scheme death benefits
As per the link earlier in the article in respect to the different types of pension scheme payments on death that will now be in scope of IHT, interestingly a lump sum paid on death from a Defined Benefit scheme will be included and will become subject to IHT. The detail in HMRC’s notes states that all life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the changes in this consultation document. Therefore, it may be worth checking how a member’s death benefits are paid to enable the best route to take.
Discretionary benefits or not?
Traditionally, having a pension scheme pay out on a member’s death at the discretion of the pension trustees meant there was no IHT charge for the beneficiary, as the funds were not deemed to be the property of the member. Given the new IHT rules, it will be interesting to see if full nomination will become more prevalent now that the IHT ‘benefits’ are removed from trust based schemes.
Qualifying Non-UK Pension Schemes (QNUPS)
QNUPS legislation was brought in to ensure that non-UK pension schemes that met certain criteria would receive the same IHT exemption as UK registered pension schemes on death. Since their inception, both UK residents and non-UK residents have used these schemes as an efficient way of funding retirement while also reducing IHT liabilities. With the IHT benefit now removed, the main draw of these schemes is likely to be non-UK residents using them for retirement and generational planning i.e. the ability to pay a spouse / dependant’s income or lump sum without the need for probate.
Qualifying Recognised Overseas Pension Scheme (QROPS)
For the avoidance of doubt, the reason that QROPS are currently exempt from UK IHT on death is because they meet the criteria as laid out within QNUPS legislation. By definition, all QROPS are also QNUPS. As such, it is assumed that QROPS will also be within scope of UK IHT and impacted by these changes.
Impact on Isle of Man (IOM) Pensions
While most IOM pension schemes (both individual and company) with IOM residents meet the requirements to be a QNUPS, the majority will not be aware of the fact. However, the new IHT rules place these schemes within the realm of UK IHT. Therefore, any current IOM resident who has been resident in the UK for more than ten of the last 20 years at the time of death, will likely be subject to UK IHT on the value of their remaining pension fund on death. As mentioned previously, this may cause difficulties for the scheme administrator. Additionally, the individual (or their beneficiaries) may not be aware that the pension is part of their IHT estate.
If someone has changed their residence to the IOM, any UK pension scheme will be part of their estate for UK IHT purposes as non-UK residents will still be liable for IHT on their UK situs assets, even where they meet the new non-UK residency test on death. Therefore, it would seem sensible to consider moving the pension fund to the IOM to ensure that once they are non-UK resident for over ten years this will not form part of their taxable estate.
International QROPS Considerations – The OTC
Not included in the two changes listed at the beginning of this article, but still a relevant consideration is the change from ‘jurisdiction’ to ’country’ in relation to the Overseas Transfer Charge (OTC). The introduction of the HMRC OTC in March 2017 meant that members would pay a 25% tax charge on a transfer to a QROPS that was not in the same jurisdiction that they lived in. This effectively meant that transfers to IOM were only viable for IOM residents. Likewise, transfers to Malta and Gibraltar were only viable for residents of the EEA (European Economic Area), as the EEA was classed as one jurisdiction. A slight change from ‘jurisdiction’ to “’country’” now means that transfers cannot be made to Malta or Gibraltar without incurring the 25% OTC unless the member is resident there (and stays for at least five years after the transfer).
As new business levels undoubtedly fall, those non-UK residents already holding a QROPS are more likely to keep them and less likely to transfer to a UK SIPP.
Moving forwards, depending on other assets and the member’s own UK IHT position, it may be a decision between paying a 25% OTC and transferring to a QROPS now or a potential 40% UK IHT bill (and possibly income tax) for the recipient on death, on a pension pot that has remained in the UK.
International QNUPS Considerations
International pensions for expatriates have traditionally used QNUPS as a vehicle to add the IHT benefits to the other benefits offered by a QUNPS i.e. saving for retirement and having a vehicle that solves probate and succession planning issues. With the removal of the UK IHT exemption, and the new objectivity of the residency rule over the previous seemingly subjective domicile rule, this potentially brings more types of pension arrangement into the picture.
Depending on where the person is expecting to retire, and the tax treatment and definition of foreign pension income in that country, a more flexible type of arrangement may be more suited which could lead to more opportunities.
Conclusion
Two major changes made in the UK Autumn budget will impact UK residents with pension plans; the introduction of UK Inheritance Tax (IHT) on pension funds and the removal of the concept of ‘domicile’, replacing it with a residency-based test for UK IHT purposes. While the impact of these changes is clear cut in some respects, there remains to be some unanswered questions as we await further consultations.
We will continue to review the situation and provide updates as required. In the meantime, should you wish to discuss your options regarding your UK pension scheme, please do get in touch with Boal & Co.
John Batty
Technical Sales Manager
