AJ Bell is urging the government to exempt pensions and ISAs from inheritance tax (IHT) as part of a drive to simplify the UK savings landscape.

In response to the Office of Tax Simplification’s recent call for evidence on IHT, AJ Bell has highlighted arcane HMRC rules which currently force most providers to exercise discretion over how pension death benefits are paid out.

This is because where discretion is not used, or a pension is transferred or contributions increased while someone is in serious ill-health, the money left behind is subject to IHT. This could leave their loved ones with a 40% tax bill.

“However, exercising discretion can lead to significant delays – sometimes of more than a year – in making payments while all the necessary information is gathered. In the most complex cases the costs associated can run into thousands of pounds,” the firm said.

“Cases where transfers are made in ill-health – and therefore potentially liable to IHT – are particularly difficult because providers are forced to withhold an amount equal to the potential IHT liability until the estate has been settled.

“Providers do this because HMRC has the power to pursue scheme administrators for any unpaid IHT. However, this process regularly adds unnecessary delay and uncertainty for people who are often in emotional distress.”

In addition, AJ Bell believes the current system where pensions are, where provider discretion is exercised, not subject to IHT while ISAs are always subject to IHT increases complexity for savers. Making ISAs exempt from IHT would make the system much simpler, with an exception for contributions that are made while in ill health and to avoid IHT.

AJ Bell technical director Peter Hopkins commented: “Rules effectively forcing pension providers to apply discretion to shield savers from IHT are from a bygone era and need to be revisited.

“Almost everyone assumes pensions are always IHT-free and that funds automatically go to the beneficiaries they’ve chosen. Few realise that pensions are only free of IHT if providers go through a discretionary process resulting in delays and costing money that would otherwise go to the bereaved.

“The government could remove these costs at a stroke by exempting all pension death benefits from IHT, including those paid without discretion. It makes no sense for schemes to second guess nominations solely to avoid IHT. This is an anachronism that doesn’t fit pensions in the 21st Century. At the same time, the government should consider making ISA exempt from IHT so there is one simple set of IHT rules covering long term savings whether they are in an ISA or pension tax wrapper.”

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