The hidden costs of acting with discretion

The Office for Tax Simplification’s (OTS) final report on inheritance tax (IHT) again acknowledged the complex interaction between IHT and pensions, and asked HMRC to get its guidance in order, but any firm recommendations for change were noticeably absent.

I can’t help thinking this is a missed opportunity to reverse some of the hidden costs associated with one area of the IHT rules in relation to pensions: providers having to properly exercise discretion over the payment of death benefits.

Why does discretion matter?

If pension scheme trustees or administrators exercise proper discretion over who receives pension death benefits, then these will not be subject to IHT.

At present, clients can give their expression of wish to a provider but this cannot be binding or the IHT benefit would be lost. Even in the simplest of cases, providers will typically request a copy of the deceased’s will and details of financial dependence of those left behind so they can see a full picture.

There can be delays at what is obviously a sensitive time and the cost of gathering even basic information can result in additional fees to a case – all just to ensure discretion is being exercised properly.

In cases where there are multiple potential beneficiaries or more complex family situations, the time and cost of investigating these so that faceless trustees (in the eyes of beneficiaries) can follow a largely academic process can easily reach significant levels.

Then there are the contentious cases, where a provider feels they have spent due care and attention to properly consider the situation and exercise their discretion but one or more parties are unhappy with the decision. These cases are commonly being referred to the Pensions Ombudsman (PO), again meaning further delays and costs to determine what acceptable discretion actually is.

Furthermore, these cases are on the rise. According to the records of PO decisions, the number of death benefit cases referred to the PO since increased flexibility was introduced in 2015 has more than trebled when compared to the previous five years. Death benefits represent 10% of the total PO decisions to date in 2019.

A way forward?

Although the complexity of each case clearly varies, exercising discretion comes at a cost that will feature every time, meaning those who don’t pay IHT are just facing a tax by another name.

Recommendation 10 in the OTS report is that a payout from term assurance policies not written into trust should be free from IHT. So why can’t there be a similar carve-out for discretionary pension death benefits?

Getting rid of this inefficient process would save cost, administration time and distress for the people involved. There would be little or no tax loss to the exchequer, and HMRC can free up their time for proper investigations should they wish to do so.

Senior Technical Consultant

Charlene is a Chartered Financial Planner with over 10 years' experience in financial services. She joined AJ Bell in 2014 after relocating to Manchester from Bristol, where she held financial planner and paraplanner roles at leading firms. In addition to analysing and commenting on technical and regulatory issues, Charlene is also responsible for designing and providing technical training for AJ Bell staff.