Most unused pension funds and death benefits to be brought within scope of IHT

HM Revenue & Customs’ (HMRC) 22 July 2025 policy paper confirms that, from 6 April 2027, most unused pension funds and death benefits payable from a registered pension scheme will be brought within the scope of inheritance tax (IHT) irrespective of whether the scheme has discretion over the payment of death benefits.

Bringing inherited pensions into the IHT regime will mean that if the value of pension savings takes the value of the deceased’s estate over the IHT threshold (currently £325,000 – or £500,000 if it includes the family home which is passing to direct descendants – and remaining at this level until 2030), tax will be levied (subject to other exemptions that might apply, such as the exemption on inheritance by a spouse/civil partner). The current IHT rate is 40%.

In response to concerns raised during the consultation process, the Government has changed its initial proposition (see here) and allowed two easements.

• The deceased’s personal representatives (PRs) will be responsible for reporting and paying any IHT due rather than the pension scheme administrator (PSA) as originally proposed – giving the PSA this responsibility was viewed as problematic for schemes both from a timing and obtaining information perspective.
• Death in service benefits (discretionary and non-discretionary) will be excluded from IHT. This maintains the current position for those schemes that pay such benefits under discretion but represents a change for schemes including most public sector schemes that pay non-discretionary death benefits. It aligns with the Government’s aim of achieving consistency in IHT treatment. However, it appears to still leave other lump sum death benefits such as those provided following death in deferment and after retirement (e.g. a defined benefit 5-year guarantee lump sum) in scope, death in service being defined as payable in respect of an active member in scheme-specified employment immediately before death – we will need to see the final legislation to clarify this point.

Reasons for the IHT changes

At present, many unused pension funds and death benefits are not taxed under IHT when a member dies. However, because of a rise in pension schemes being “used and marketed as a tax planning tool to transfer wealth without an Inheritance Tax charge, rather than for funding retirement”, the Government wishes to change the system to “deliver a fairer, less economically distortive tax treatment of inherited wealth and assets”. This follows the abolition of the lifetime allowance meaning there was no longer a limit on the amount that an individual could save in their pension and potentially pass on to their dependants.

Which death benefits will be excluded from IHT?

Death in service benefits (see above), dependant scheme pensions and charity lump sum death benefits will not be in scope of IHT from 6 April 2027.

The current exemptions from IHT for property passing to a spouse or civil partner, charity or registered club, will also continue to apply to the payment of a relevant death pension benefit. Delay in payment or there being a discretion as to payment of the benefit will not lead to the exemption being disapplied.

Joint life annuities are also exempt either because of the spouse/civil partner exemption or because the survivor element payable to another person is not in scope of IHT. (This means that unused defined contribution (DC) savings, dependants’ drawdown pensions and lump sums payable following death in deferment or in retirement will be in scope).

How will the PR-led IHT reporting and payment process work?

PRs already report and pay IHT on a deceased’s estate (including non-discretionary pension benefits) but will now have to do so in respect of IHT due on discretionary pension death benefits. The existing 6-months from date of death deadline for paying IHT will remain – this means that schemes have less time to process death benefits than they are used to (currently two years from notification of death) and will need to work quickly to determine beneficiaries.

The consultation response includes a high-level outline of the reporting and payment process.

Stage 1: PRs will notify the PSAs about a member’s death and whether there is a surviving spouse or civil partner. PSA will provide the value of unused pension funds/death benefits with the PR within 4 weeks of this notification. The PSA will also inform the PR of the split of pension benefits between exempt and non-exempt beneficiaries.

Stage 2: PRs obtain information from every PSA and other parts of the deceased’s estate, value the total estate and work out whether IHT payable.

Stage 3: If IHT is payable, PRs will work out how much is attributable to the different pension elements of the estate, provide an account to HMRC and tell the beneficiaries of the IHT amount due on their element. The IHT can be paid in one of three ways (see below).

Stage 4: Intersecting with stages 1-3, the PSA and trustees will identify beneficiaries and distribute the pension benefits. They will need to tell non-exempt beneficiaries that IHT may be payable, they have joint and several liability (see below), and the options for payment (see also below).

Stage 5: The PRs will deal with adjustments to the estate and sending amended IHT accounts to HMRC.

The payment process – three options

To address potential issues regarding liquidity and PRs not having the funds to pay tax due, there will be three options for PRs and beneficiaries when paying IHT.

• Option 1: PRs pay IHT directly from the entire free estate and then apply for probate. If need be, PRs can get reimbursed from the pension beneficiary and then pay the IHT pension amount to the non-pension beneficiaries.
• Option 2: A pension beneficiary can direct the PSA to pay the IHT to HMRC if it is £4,000 or more under a new scheme that will be established. The PSA will become liable for the IHT if they do not pay the tax within 3 weeks. If the IHT is less than £4,000, the PSA has discretion as to whether to pay the IHT.
• Option 3: A pension beneficiary can take their pension benefits in full and pay the IHT due directly to HMRC and ask for refund of any income tax paid on the IHT charge.

Liability of beneficiaries

Beneficiaries will be jointly and severally liable for IHT due on pension benefits payable to them from the point at which entitlement arises.

Income tax changes

Income tax legislation will be amended to prevent a pension beneficiary from paying double tax. Income tax will not be payable on the amount of the death benefit equal to any IHT due on that benefit. Without such changes, a beneficiary could receive pension income that has already been subject to IHT and then get taxed again on the full amount under income tax provisions.

The changes will also allow income tax to be adjusted to account for any decrease in IHT liability resulting from direct payment of IHT from the death benefits. Allowing for an adjustment will prevent underpayment of income tax.

There will be a procedure for recovering overpaid tax.

What is the impact of the changes?

The Government expects that in 2027-2028, the new measures will mean 10,500 out of 213,000 estates with inheritable pension wealth will have to pay IHT where they would not otherwise have done so and around 38,500 will pay more IHT. The average IHT liability will increase by approximately £34,000 for those impacted.

Next steps

The changes will be brought in by Finance Bill 2025-26 amendments to the Inheritance Tax Act 1984 and the Income Tax (Earnings and Pensions) Act 2003. Responses to the draft legislation can be submitted until 15 September 2025.

Legislation will be introduced to update the information sharing framework to allow for the required exchange of details between PRs, PSAs and pension beneficiaries.

The PR-led IHT reporting and payment process is still being worked upon by HMRC and further guidance tools and process maps will be produced before the changes come into effect.

Trustees will need to liaise with their advisers to confirm that scheme administration processes will be adjusted to comply with the new requirements, albeit the changes will not need to be as expansive as they would have been if PSAs were required to lead the reporting and payment process. Changes will include processing any IHT payments that are paid direct to HMRC in respect of a beneficiary. They will also need to work out which benefits are in scope of IHT and how scheme communications and documents need amending to reflect the new regime.