Government-backed workplace pension scheme the National Employment Savings Trust (Nest) is consulting on new rules that will finally end an inheritance tax (IHT) trap, previously criticised by the industry.
Currently the pension scheme - the largest in the UK, with 5.6 million members at the end of September - is the only one where trustees do not have full discretion when deciding who should receive a lump sum death benefit from a member’s pension arrangement.
Tax rules mean that when trustees don’t have this discretion the value of the lump sum will be counted as part of the deceased’s estate for IHT purposes on their death.
According to Graham Peacock, managing director of smaller rival Salvus Master Trust, this is becoming a serious problem since the government-backed master trust started to allow members to transfer other pension pots into their Nest pot, something that was previously banned.
He said: “Nest is offering an [annual management charge] AMC of 0.3 per cent, which is very competitive.
“If you transfer into Nest all of your pension pots which are currently IHT exempt, you can create an IHT liability.”
In the consultation paper, Nest explained that this rule was created when the scheme was first established in 2011.
At the time, it was decided that exercising discretion on death benefits was not the right option for Nest, given the need to deliver a low-cost scheme to millions.
This was because, among other things, “the size of member pots in the early years of auto-enrolment was likely to be very low, and the potential cost of assessing individual cases was likely to be disproportionately high,” the scheme said.
Nest confirmed there is an increased risk from its “approach of not applying discretion, resulting in potential IHT liabilities,” which will impact more of its members than it had previously considered.
The scheme said: “This could also deter employers from choosing Nest.
“They may not wish to use it for their higher paid workers – those more likely to be subject to IHT in the future – and may prefer to use one scheme for all workers.”
However, due to cost restrictions the scheme is proposing an opt-in solution, which is is currently consulting members on.
Members who wish to have trustees’ full discretion will have to complete a wish form, which will address the IHT issue that some individuals may otherwise encounter, Nest said.
Requiring members to opt in to discretion, rather than applying it across the board as a default, means that Nest won’t need to introduce “an expensive, administratively complex system”.
According to Sir Steve Webb, director of policy at Royal London, and pensions minister at the time Nest was created, this opt-in approach can result in the vast majority of members failing to take advantage of the change.
He said: “It could still be the case that someone who could have benefited from the new arrangement will fail to opt in.