Wednesday’s Budget contained a plethora of tweaks, including a promise that state pensioners will not need to file simple assessment returns for small amounts. On the thorny issue of how to implement inheritance tax on pensions, the Treasury is now saying there will be another option.

At the 2024 Budget,  the chancellor sent shockwaves through the pensions world by bringing defined contribution pots into scope for inheritance tax.  

The problem is how to collect the tax; an initial proposal by HM Revenue and Customs to make pensions administrators responsible was roundly rejected by the industry. A second proposal put the entire burden on personal representatives again attracting criticism for creating unreasonable pressure on grieving family members.  

Now, the Treasury is offering a third way: “Personal representatives will be able to direct pension scheme administrators to withhold 50% of taxable benefits for up to 15 months and pay inheritance tax due in certain circumstances.”  

In addition, “personal representatives will be discharged from a liability for payment of inheritance tax on pensions discovered after they have received clearance from HMRC”. This is likely in response to concerns that families might not know what pensions someone had – or that the account holder was themselves unaware, given the thousands of lost pots in the country. 

The change will take effect from 6 April 2027, when IHT on pension starts to apply. 

Head of personal finance at Hargreaves Lansdown, Sarah Coles, said: "Such changes could bring some much-needed flexibility and clarity to a difficult process.”

Reeves has apparently sought to pre-empt questions on the taxation of state pensioners as the full new state pension is now dangerously close to the frozen income tax threshold.  

She said: “We are ensuring that people only in receipt of the basic or new State Pension do not have to pay small amounts of tax through Simple Assessment from April 2027.”   

The tax liability on state pensioners will grow in future years, with Steven Cameron, pensions director at Aegon, predicting that if the triple lock was to lead to the same increases from now until 2031, it could reach more than £500.    

“The chancellor has offered some assurances by saying pensioners won’t have the admin burden of completing simple assessment tax returns. However, importantly, this is not the same as waiving the tax. The government is to look into alternative approaches to dealing with the tax charges. It’s important that this made as easy and stress-free as possible for pensioners,” he said. 

On 7 November, a House of Commons briefing paper about ‘Taxation of state pension’ noted that when the state retirement pension was first introduced in 1946, it was taxable, and that this approach has remained unchanged.  

A 2013 Office for Tax Simplification report looking at making the state pension exempt argued that this was not a realistic option because of “the large hole in the public finances it would create”, adding: “There are significant issues of fairness towards other taxpayers, especially as the wealthiest pensioners would benefit most, and over the last decade, pensioners have seen their incomes increase faster than other groups.” 

That report also did not recommend extending PAYE to the state pension because of costs and operational risks but said this should be kept under review, while the Low Incomes Tax Reform Group has said it should be done.