Can married couples inherit tax-free pension pots after the Budget change?

I have a question about the changes to the tax on inheritance pensions announced in the Autumn Budget.

If you are married and have no defined contribution pensions when you die, will your spouse inherit the pension tax-free from April 2027, as would be the case for the home, savings, etc.?

Would your spouse then be able to draw on the pension at the marginal tax rate?

If your spouse dies, will the combined inheritance tax deduction be applied to any remaining pension?

Thank you. I think a lot of people my age would be interested to hear the answers.

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Steve Webb replies: Before we move on to what has changed in the budget, it is important to realize that the basic features of the inheritance tax have remained unchanged.

This means that:

– You still have a ‘zero rate’ of £325,000 per person to set against the value of your estate. This figure will remain the same until at least 2030.

– Any unused zero interest band upon the death of the first member of a couple can be used by a surviving spouse.

– You still have a ‘housing zero rate’ of up to £175,000 per person, meaning your total benefit is £500,000 if you pass your main home on to your direct descendants.

– Any unused portion of this can also be transferred to a surviving spouse, meaning the grant for a married couple could be £1 million.

– Transfers between spouses (but not members of unmarried couples) remain free of inheritance tax.

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The main thing that has changed (with effect from April 2027) is that you now have to include the value of certain pensions when working out the value of the estate for inheritance tax purposes.

This mainly includes what the government calls ‘unspent’ balances in defined contribution pensions, as well as certain death benefits under defined benefit or defined contribution pensions.

The government estimates that in just under 40,000 cases, estates that would have been subject to inheritance tax anyway (before the budget changes) will now face additional inheritance tax as pension assets need to be added.

Another 10,000 estates each year will now receive an inheritance tax bill because pensions are included, but this would not have been the case if pensions were ignored.

Therefore, regarding the first part of your question, the answer is ‘yes’: an unused DC pension can be left to a spouse and is not subject to inheritance tax, despite the changes in the budget tax.

And the surviving spouse can draw on that pension pot in the usual way, paying income tax on the money he withdraws.

After the death of the spouse, the estate is valued in the normal way – but now including pensions – and any remaining inheritance tax is applied to this total amount.

But in terms of the practical aspects of it all, the new system will unfortunately be much more intrusive for grieving families.

As things stand, the person settling the estate (the so-called ‘personal representative’) must already assess the value of the assets in the estate and check whether they are large enough to warrant paying inheritance tax.

This must all be arranged before the inheritance can be granted.

But in the new world where pensions are also part of the estate, the government has indicated in its statement consultation on inheritance tax on pensions that people will have to apply to all ‘relevant’ pension schemes to which the deceased was affiliated.

Broadly speaking, this means all defined contribution pensions and any other pensions from which a death benefit or the like might be payable.

The personal representative will have to obtain information from each pension scheme and provider about the amount of the remaining pension, who the beneficiaries are, and so on.

Once they have obtained this information and gathered information about all other assets, they will need to use a new online HMRC calculator which will work out how much inheritance tax is due.

The calculator indicates how the inheritance tax assessment should be divided among the various pension providers and how much still needs to be paid by the personal representative.

The personal representative must then inform each pension scheme of the outcome of this calculation and the schemes will then assess how much inheritance tax they should pay directly to HMRC.

Once the inheritance tax has been paid, the pension scheme can release the balance of funds to the beneficiaries.

My opinion is that this whole process is likely to be terribly bureaucratic and could significantly delay the already lengthy process of sorting out a person’s financial affairs after their death.

To give an example, if a pension provider is inefficient and takes a long time to answer questions, the entire process will be postponed because the final inheritance tax assessment can only be worked out after all information has been collected.

There is still time between now and 2027 for HMRC to rethink how all this will work in practice.

It is one thing for a chancellor to simply announce in a few words in a budget speech that pensions will now be subject to inheritance tax, but working out the practical implications is a monumental task.

It is crucial to ensure that the Chancellor’s desire to raise revenue does not come at the cost of adding red tape at what is already a difficult time for many families.