Inheritance tax on pensions sounds alert for savers to gather small pots as probate chaos looms

Pension savers are being advised that consolidating scattered pension pots into one place could prevent an admin nightmare for their families after new inheritance tax (IHT) rules come in next April.

From April 2027, unused money-purchase pension assets will be included in estates for the calculation of IHT and this is already having consequences. Many pension savers are deciding to take their tax-free lump sum or draw down more heavily on their pension pots in order to spend or gift, or in some cases buy annuities, so that they are not leaving a surplus pot that will be taxed at 40 per cent at death. And potentially double-taxed if someone dies at age 75 or over, as a beneficiary may also pay income tax on the inherited pension fund at their marginal rate.

But wealth management firm Evelyn Partners warns that another step in preparing for this major change could prove wise, due to the IHT and probate rules around the administration of estates that include pensions.

Andrew King, pensions technical specialist at Evelyn Partners, says:

‘Pension consolidation can be a good move for a number of reasons [see below], but the inclusion of unused pension pots in IHT liabilities will add extra urgency for many families. This is because having several, scattered defined contribution pension pots could land their personal representatives* with a real admin headache, interest charges from HM Revenue & Customs and potentially a lot of stress.’

The Government recently rejected House of Lords recommendations to extend the amount of time from death that grieving families will have to pay IHT bills once pensions are included from six to 12 months. IHT will remain due from the personal representative (PR) at the end of the sixth month after the date of death.

Stress, interest charges – and probate delays

Mr King says: ‘The way the rules have been drawn up for IHT from next April, the PR will have to go to each pension provider and try to access funds within the six-month deadline from death for the payment of IHT. Where there are several pension pots with different providers, this could not only prove a heavy administrative burden but also potentially hit the estate with interest charges.

‘Many older pension providers have been acquired by consolidater-firms, and this can lead to slow response times. So many estates and beneficiaries are going to face late interest payments at the rate of 4 per cent above the Bank Rate (which would currently make interest due at 7.75 per cent) if they miss the IHT deadline due to administrative logjams.

‘Moreover, battling pensions admin could delay probate. A Grant of Probate or Letters of Administration will not be issued unless IHT has been properly reported and, where tax is due, paid or payment arrangements agreed. Without probate, the PR will struggle to access the deceased’s other assets.

‘While the IHT bill can sometimes be paid direct from the deceased’s bank accounts before probate, or via an instalment schedule, there are already well-documented delays in the probate process and this could add to those delays from April 2027, leaving PRs in a no-man's land in terms of winding up the estate.’

Extra concerns for family businesses

Mr King says: 'It’s worth adding here that the capping of business and agricultural property reliefs that came into force on 6 April this year could add to the complexity and stress where family businesses are concerned. As the new £2.5million cap on reliefs will draw many more family firms into the IHT net, they could face an even greater administrative burden, as the business will have to be valued and many entrepreneurs own illiquid assets, like their business premises and plant, in their pensions.

‘The Government will allow PRs to tell pension providers to put a temporary stop on paying out 50% of the money from a pension for up to 15 months – ensuring that PRs, who are liable for IHT due, have access to pension assets to pay the IHT. While interest will still be charged from the sixth month, this does allow some breathing space for a complex estate to be sorted – for instance where the pension contains illiquid assets such as property or private company shares.

‘The time should allow liquidity to be created to pay the tax, and it means that the 40 per cent IHT liability for a pension is totally covered by the 50 per cent being withheld. But it is also essentially a tacit admission on the part of the authorities that the winding up of pension assets could take a lot longer than the allotted six months to pay the IHT bill. It really is disappointing that the Government did not see fit to extend the IHT deadline to mitigate all of this.

‘What we might well see from now on is a much greater use of professional PRs – typically the solicitor - where families realise the job is simply going to prove too much for a relative or friend to handle and are prepared to pay for the service.

‘What can be done to make life easier for PRs where they are family members or friends? One relatively simple step is for older savers who hold multiple pension accounts with different providers to consolidate them into one or two pots. For our clients, this will often be done as a matter of course at an early stage in the relationship - as long as their pots and schemes are suitable for consolidation [see below].

‘Those not taking advice can do a DIY consolidation job but they should take on board the caveats we detail below. In the continued absence of long-awaited pension dashboards, it is essential that everyone at least keeps track of all their pension savings, especially where they have moved around between jobs during their career.

‘Whether they consolidate or not, one simple step that will make life a lot easier for their PR is to keep clear records and documentation of not just all pensions held but also all other financial assets, so the PR will have all relevant information at their fingertips.’

Pot proliferation

Since auto-enrolment, many more workers now collect a succession of often small money‑purchase / defined contribution pension pots as they move jobs. Research suggests about 3.3 million pension pots are ‘lost’ in the UK, adding up to about £31.1billion - an average pot size of nearly £10,000.[1]

More than a decade after the Financial Conduct Authority first floated the idea of a ‘pension dashboard’ – allowing individuals to see all their pension arrangements in one secure online place – dashboards have yet to be launched. It was revealed in 2024 that the cost of the project had surged since 2020.[2]

Mr King continues: ‘The UK’s pension savers can be forgiven some confusion over Government announcements on workplace pensions. While the pensions dashboard project has become something of a White Elephant, successive Governments have floated alternative industry solutions to the problem of people accumulating multiple, often small, pots during their working lives.

‘We’ve had “pot follows member” versus a “default consolidator”, and then “pot for life”. But savers would be wise not to wait around for these ideas to materialise before getting a grip on their pensions. As the cogs of pension policy grind slowly on, today’s pot‑juggling savers now have an additional reason to act – the difficulties that scattered savings will create for their family at death.

‘Many of these pots will have been administered entirely online, making them even harder for personal representatives to track down.’

The pros and cons of consolidating multiple pensions

Mr King says: ‘It is evidently sensible in most cases to have pension savings in one place. Managing multiple pots is risky and time‑consuming: it requires effort to keep track of them all, and pots can be forgotten, with hard‑earned savings effectively lost.

‘Even for those who keep good records, it’s a plate‑spinning exercise to manage investment choices, assess risk, gauge performance and work out what income total savings might provide at retirement. Having a clear picture of overall pension funding is especially important as retirement nears – but ideally much earlier, while there is still time to act.

‘Older legacy schemes can charge higher fees, impose exit penalties and restrict some of the flexible options and death benefits introduced with the 2015 pension freedoms – for example by not offering flexible drawdown. In these cases, consolidation can bring clear benefits, as can access to a wider choice of investment funds.

‘That said, the opposite can also be true for some savers, who may be better off keeping one or more legacy or deferred schemes. In short, it is not essential to have a single pot, but it is far easier to take control of retirement savings if they are not spread all over the place.

‘Ideally, today’s workers would not accumulate large numbers of small DC pots in the first place. Younger and middle‑aged employees who have benefitted from auto‑enrolment but are building up multiple pots should consider rolling them up as they go along – either into their current workplace scheme or into a personal pension such as a SIPP. 

‘Having fewer pots makes it easier to monitor investments and performance, which in turn gives greater clarity over the size of the pot at retirement and the income it might generate. However, there are variables and complexities, so holders of multiple schemes should look carefully at their savings before embarking on a DIY consolidation.’

DIY pension consolidation

If you plan to go it alone, Andrew King highlights the following points:

• Defined benefit schemes or plans with “safeguarded benefits” are highly likely to be better left alone. In any case, defined benefit (final salary) pensions worth more than £30,000 cannot be transferred without advice. 

• Most modern DC workplace pensions can be consolidated into a current workplace scheme, or a personal pension such as a SIPP. 

• In most cases, it makes sense to remain in your active workplace scheme, where employer contributions continue, even if deferred pots are consolidated elsewhere. 

Which pots are worth keeping?

Deferred defined benefit, or final salary, schemes that offer a guaranteed income for life and remove investment risk are usually worth retaining. 

‘The Financial Conduct Authority and the Pensions Regulator believe it is in most people’s best interests to keep their defined benefit pension,’ says Mr King. ‘That is even more the case now than in recent years, as relatively high interest rates and bond yields have reduced transfer values, meaning members are typically offered far less to leave these schemes than they were a few years ago. Even so, if the value exceeds £30,000, regulated financial advice is mandatory.

‘Those with smaller DB pensions may feel the income offered is not worth keeping, but caution is needed. A guaranteed, index‑linked income to supplement the state pension is something many people pay dearly for via annuities, and there may also be valuable spousal benefits. Circumstances can change if a transfer offer is clearly favourable, or if ill‑health and limited life expectancy make a guaranteed income less appealing, particularly close to retirement.’ 

It is not only final salary pensions that require caution. 

‘Some DC schemes include “safeguarded benefits” such as guaranteed annuity rates, protected tax‑free cash or spousal benefits. Savers should think carefully before giving these up, and advice may be helpful to understand their value. Similarly, some older schemes impose exit penalties, making it preferable simply to hold on to them.’ 

How to consolidate

Employees have two main options: rolling deferred pots into their current workplace scheme, or consolidating them into a personal pension such as a SIPP.

Mr King says this is largely down to preference: ‘Many – particularly younger workers – may find it simplest to roll DC pensions into each new employer scheme, provided they are happy with the fund range and fees. Larger workplace pension providers now offer transfer services that are quite quick and straightforward, though you will need to supply details such as policy and National Insurance numbers.

‘SIPPs tend to suit those who want a broader investment choice and a more hands‑on approach. While SIPPs carry an account charge, these have fallen, and such accounts can make ad‑hoc, lump-sum contributions easier than a workplace scheme. They may also offer greater flexibility when accessing funds.

‘Even where a SIPP is used to consolidate old pots, it usually makes sense to remain in the current workplace scheme to benefit from employer contributions and salary sacrifice. Net pay arrangements also ensure all tax relief is applied automatically, avoiding the need for higher‑rate taxpayers to reclaim it.’

The small pots issue

Mr King says: ‘Recent evidence suggests more people are cashing in small pots in full, either before or early in retirement.[3] Some will need the money, and others may be using small‑pot rules deliberately. Provided tax has been considered and sufficient savings exist elsewhere, that may be reasonable.

‘However, many people cash in pots – sometimes well above the £10,000 small‑pot threshold – simply because they feel they are “not worth keeping”, when collectively they could materially boost retirement income. With dashboards delayed and structural reforms like “pot for life” some way off, savers can struggle to assess their total retirement fund or track performance.

‘As a result, more people may be tempted to discard pots they see as insignificant or fail to monitor investments properly, increasing the risk of falling short in retirement. That under‑appreciation of fragmented savings is yet another reason to take control.’

Taking control of your pensions with advice

Mr King says: ‘The stereotype is that financial planning is only for the wealthy, but many savers who assume it is not for them could benefit from advice, not least because it improves retirement outcomes. Many simply lack the time, confidence or motivation to manage pensions themselves. Advice can still add value for those with modest savings, particularly where plans are complex or legacy pots are poorly understood.

‘The closer someone is to retirement or taking benefits, the higher the stakes become around consolidation and transfer decisions – and the more valuable advice tends to be. A financial planner can identify which pensions to keep, whether consolidation makes sense, how to move into drawdown and whether investments remain appropriate.

‘Crucially, they can also place pension savings in the context of someone’s wider financial position, factoring in other assets and income. Most people underestimate what they will need, and advice can at least open their eyes to that reality.’

Evelyn Partners can provide both routes to consolidation. The DIY option is available through its consumer-facing digital investment platform Bestinvest, which offers an award-winning SIPP. While financial planning clients will have the process managed under advice, which can be accompanied by investment management services where necessary.

NOTES  

*Personal representative(s) refers to the executor(s), where this a will, or administrator(s), where there isn’t a will or it’s invalidated, of an estate and will often be a family member or friend, sometimes in conjunction with a solicitor. Families can also appoint a professional as the sole personal representative, usually a solicitor. 

[1] Brits missing £31.1bn in unclaimed pension pots | Pensions UK 

[2] NAO 10 May 2024:  

Investigation into the Pensions Dashboards Programme - NAO report   

[3] FCA April 2024:  

Retirement income market data 2022/23 | FCA