Are Pensions On Death Inside or Outside Your Estate for IHT?
Published / Last Updated on 26/01/2024
We have covered this area many times across this website but even just in the last week we were discussing pensions on death with a client and again they thought their pension fund would be included in their estate on death and so may be subject to inheritance tax (IHT) and should be included in their Will.
Pension in Trust or Not?
Most pension schemes are set up as a trust. They are set up as discretionary trusts (you may have heard the term Pension Scheme Trustees) and on death, any benefits due are paid directly to your loved ones at the discretion of the Pension Scheme Trustees.
You will usually complete an ‘Expression of Wishes” on death as part of your pension application form. This means you have told the trustees who you would like to benefit.
Your pension scheme is in a discretionary trust meaning benefits are paid out at the discretion of the trustees i.e., they will take your wishes into account, but they still have the final decision as to whom the pension fund is paid out to.
For example, if you had excluded your partner or children from your pension benefits and want the benefits to be paid to your local charity, the pension trustees may ask the executors of your estate if you had any financial dependents e.g. partner/children and may then override your wishes and pay benefits to your partner/children. This is at their discretion and also then means your pension fund is not part of your estate, it is held in trust meaning it is not subject to inheritance taxes.
Sometimes there may be taxes due if you have exceeded the lifetime allowance and died after age 75 or you were diagnosed with a terminal, life shortening illness and transferred your salary related/defined benefit pension scheme to an invested linked/defined contribution pension scheme that can pay out benefits on death with 2 years of your death.
Pension Schemes Not Set Up Via A Trust
This is not so common, but there are many pension schemes that were not set up via a trust. Some pension schemes, more recently in the 1980s and 1990s may have been set up by contract rather than by trust.
Sometimes known as an ‘exchange of letters’ or an ‘exchange of contract’, your employer and you sign an individual contract to make payments into a pension scheme for you.
From personal experience, we have recently seen contract-based schemes with Legal and General and Prudential and no doubt many others are around.
We have seen Executive Pension Plans (EPPs), Company Money Purchase Schemes and even some Teacher’s AVC (additional voluntary contribution) schemes.
In most cases your employer will have made a promise to the you to contribute to the pension scheme every month, but their obligation ends there. Your employer has no responsibility for HMRC reporting or paying Pension Protection Fund levies etc., it is the pension provider that does all of this.
These schemes are not in trust so there are no pension scheme trustees with discretionary powers, they were set up by contract and therefore, no 'expression of wishes' is completed and benefits are paid to your estate on death. This means that contract-based pension schemes may be subject to inheritance tax on death.
Check Your Pension Scheme Status
We urge you to read your pension scheme booklet or check with your pension scheme whether your pension scheme is a trust-based scheme or a contract-based scheme. In most cases, your will see the terms Trust Deed and Trust Rules or Pension Scheme Trustees, but if you do not, it may mean you have a contract-based scheme that will form part of your estate.
