Government makes significant changes to application of IHT to pension benefits

News alert 2025/03

At a glance

The Government has now settled on much of the way ahead for bringing unused pension funds and death benefits into scope of Inheritance Tax (IHT) for deaths on or after 6 April 2027. A technical consultation on draft legislation to effect the new regime has also been launched.

This News Alert summarises and analyses this important development. It replaces the News Alert we issued shortly after the Government launched an initial consultation on its proposals last year.

Key actions

Trustees of pension schemes

• Check which death benefits will fall within scope of the new IHT regime
• Review your policies and processes for managing death benefits and look to streamline these as much as possible
• Ensure that your administrator is prepared to make the necessary updates to their processes ahead of April 2027
• Consider what information about the new regime should be provided to scheme members (Defined Contribution (DC) and Defined Benefit (DB))
• Consider responding to the new consultation

Employers providing life cover

• Consider what information about the new regime should be provided to employees
• Check which death in service benefits you provide will be in or out of IHT
• Review the suitability of your death in service arrangements in comparison to alternatives in the light of the new regime
• Consider responding to the new consultation

The detail

On 21 July 2025, as part of its annual “Legislation Day” publication of draft legislation for potential inclusion in the Finance Bill that will follow the Autumn Budget later this year, the Government set out its response to its October 2024 consultation on bringing unused pension funds and death benefits into scope of Inheritance Tax (IHT) for deaths on or after 6 April 2027 (see Pensions Bulletin 2025/04).

In the consultation response, the Government acknowledged the strong opposition received from the pensions industry in the initial consultation and has made a number of significant changes to the proposals to address some of the concerns raised.

The two key changes made are to take lump sum multiple of salary death in service benefits from registered pension schemes out of scope of IHT, and to change the mechanism for collecting IHT on other pension benefits.

For deaths occurring on or after 6 April 2027:

• Unspent DC pension pots along with most death benefits payable from trusts registered with HMRC will be included in the deceased’s estate for inheritance tax purposes.
• Almost all lump sum death benefits paid from DB and DC pension schemes are within scope and only death in service lump sums are out of scope. This exclusion is however a significant change from the initial proposals.
• Dependants scheme pensions (pensions paid to a survivor usually from a DB arrangement) and the survivor element of joint life annuities (future and existing purchases) are out of scope of IHT. The latter is a new exclusion.
• As initially proposed, all pension benefits in scope of IHT will be considered alongside assets in an individual’s estate for inheritance tax purposes – with tax due depending on the overall size of the combined pension, death benefit and other estate assets. The standard inheritance tax rules include ‘nil-rate’ thresholds and exemptions for transfers of assets on death to a legal spouse or civil partner.
• The ‘Personal Representative’ of the deceased (who could be a family member) will be responsible for contacting pension schemes as well as calculating, reporting and ensuring any IHT due is paid, working with the beneficiaries. This is an increased role for the Personal Representative and beneficiaries. A pension scheme administrator will only have a liability to pay IHT to HMRC in limited circumstances.
• HMRC have three options for the payment of IHT, including a new "scheme pays" style option, so IHT can be paid from the pension scheme direct.
• If IHT is not paid within six months of the death, late payment interest charges begin to accrue. As a result, schemes are likely to come under pressure to process some death payments more quickly than is currently the case.

The draft legislation bringing about the 2027 reforms has been published. Consultation on it closes on 15 September 2025.

Lump sum death in service benefits excluded…

Lump sum death in service benefits will not come into scope after all. HMRC has confirmed they had intended these benefits, typically a multiple of salary, would be brought into scope of IHT, where paid on a discretionary basis, but have been persuaded to change their mind. They have recognised that many employers would simply have used alternative structures for such benefit provision that continue to be outside IHT.

They have also gone a step further and taken lump sum death in service benefits paid on a non-discretionary basis out of scope of IHT.

These changes mean there will be a tax reduction for public sector workers with higher earnings / larger estates rather than a tax increase for private sector workers with higher earnings / larger estates.

The consultation response is not explicit about the treatment of benefits where the same benefit is paid on both death in service and death in deferment. The draft legislation appears to suggest that where benefits are the same - such as payment of DC fund values or refunds of contributions - they would be in scope of IHT.

…as are the survivor elements of joint life annuities

The original proposals excluded from IHT all dependants’ scheme pensions, which normally relate to defined benefit arrangements and can be paid to any financial dependant but appeared to include the survivor element of joint life annuities (future and existing purchases) if the second life was not an exempt beneficiary (ie not the legal spouse/civil partner).

HMRC has now confirmed that the survivor’s rights (paid from a joint life annuity) are not part of the member’s estate and are not in scope of IHT.

…and where benefits are trivially commuted

Where a non-spouse beneficiary has an entitlement to a pension that can be trivially commuted, the IHT assessment will be against their pension prior to trivial commutation. Therefore, as a dependants’ scheme pension it will not be in scope of IHT even if it is trivially commuted for a lump sum.

IHT on pensions and estate to remain interlinked and deadline for paying IHT still unrealistic

An important consequence of bringing pension benefits into the existing IHT regime is that the whole process of assessing the estate for IHT, paying any IHT due and obtaining probate becomes interlinked with who the pension benefits are to be paid to. This is because transfers to the legal spouse or civil partner are normally exempt from IHT and who pension benefits are paid to is determined separately, often at trustee discretion.

Deadlines for the existing IHT process are also much tighter than pension schemes are used to working to. IHT must be paid within six months of the end of the month of death to avoid incurring interest and penalties. Currently pension schemes have two years from being notified of a death before tax is triggered on death benefits.

Many respondents noted that it can take many months for a pension scheme to be notified of a death, identify potential beneficiaries, obtain information on the nature of their relationship to the deceased and financial position, and determine who the benefits should be paid to.

HMRC’s consultation response is silent on whether pension scheme administrators will have a two-month deadline, as referenced originally, to notify the Personal Representative who the beneficiaries will be.

Significant burden for Personal Representatives and decisions for beneficiaries

To try and reduce the number of cases where IHT is deducted from pension benefits where none is due, HMRC has made the Personal Representative (rather than the pension scheme administrator) responsible for assessing if IHT is due and ensuring it is paid.

HMRC has set out a five-stage process, each involving several steps.

Stage 1: Establish value and potential beneficiaries

• The Personal Representative identifies and contacts all pension arrangements to notify them of the death and whether the deceased had an exempt surviving spouse or civil partner
• The pension scheme administrators must respond within four weeks with the value of the death benefits at the date of death

The pension scheme administrators can start their process to identify potential beneficiaries, obtain information on the nature of their relationship to the deceased and financial position, and determine who the benefits should be paid to.

Stage 2: Personal Representative values the combined estate

• The Personal Representative collates the information received to reach a combined total potential valuation for the estate to determine whether an IHT account needs to be returned for HMRC
• If no account is required, the Personal Representative should inform the pension scheme administrators and can get on with applying for Probate, distributing the estate and does not need to have any further interaction with the pension scheme administrators
• If an account is required, the Personal Representative needs to inform each pension scheme administrator, provide the IHT reference number and request identity information about the pension beneficiaries

Clearly the Personal Representative will be keen to receive this information well ahead of the six-month deadline for paying any IHT due and to enable distribution of the non-pension estate.

Stage 3: Personal Representative files IHT account and pays IHT (if any)

• If an IHT account is required, even if no IHT is due, the Personal Representative needs to provide HMRC with details of the value of the pension benefits and details of the beneficiaries.
• If IHT is due the Personal Representative needs to calculate the IHT due on each pension asset and report this to HMRC, the respective pension scheme administrators and the relevant beneficiaries. HMRC have said previously they will provide a calculation tool to help Personal Representatives allocate the nil-rate band between the estate and pension benefits and determine the IHT due.

The Personal Representative then needs to agree with each beneficiary how the IHT will be paid. HMRC have decided there will be three options:

Option 1: Pay IHT from the non-pensions estate

The Personal Representative can pay all the IHT due (on the estate and pension assets) from the non-pensions estate.

If the beneficiaries of the estate and pension assets are the same the Personal Representative may be able to offset the IHT paid in respect of the pension assets from each beneficiary’s share of the non-pensions estate. If they are not able to do this the Personal Representative will need to obtain reimbursement from the pension beneficiaries.

In any event the pension beneficiaries will be able to reclaim from HMRC any income tax paid on that part of the pension benefits that equals the IHT charge on the pension benefits.

Option 2: Direct the pension scheme administrator to pay the IHT

The beneficiaries can direct the pension scheme administrator to pay the IHT due on the pension benefit directly to HMRC, subject to certain conditions – see “Scheme Pays” below.

The Personal Representative would then pay only the IHT due on the non-pensions estate to HMRC.

The implication is that probate will only be granted once both the pension scheme administrators and the Personal Representative have paid all the IHT due.

Option 3: Pension beneficiaries pay IHT to HMRC

The beneficiaries can choose to take their pension benefits in full and pay the IHT to HMRC themselves. They will then be able to reclaim from HMRC any income tax paid on that part of the pension benefits that equals the IHT charge.

The Personal Representative would then pay only the IHT due on the non-pensions estate to HMRC.

The implication is that probate will only be granted once both the beneficiaries and the Personal Representative have paid all the IHT due.

HMRC have said they will work with the pensions industry to provide clear guidance and support for pension beneficiaries in respect of their options for paying the IHT and their obligations to the wider estate.

Stage 4: Distribution of pension benefits

If the pension beneficiaries are exempt or no IHT is due, the pension scheme administrator can settle the pension benefits immediately.

If IHT is due, the pension scheme administrator will need to know what choice the beneficiary has made regarding payment of the IHT.

The payment of IHT from the pension benefits will be a new authorised payment and will not be subject to income tax.

If IHT is paid by the Personal Representative or beneficiaries the beneficiaries may end up paying too much income tax on the benefits they receive. HMRC will develop systems to support reclaiming this tax and will publish further guidance.

Stage 5: Amendments

The Personal Representative will be responsible for managing any amendments and submitting any amended IHT accounts to HMRC. If more IHT is due, the Personal Representative will need to arrange with the beneficiaries for that tax to be paid using one of the three routes above. If a refund is due, the Personal Representative will be responsible for distributing it. If any adjustments to income tax are required, the beneficiaries will need to resolve these with HMRC.

New “Scheme Pays” options

“Mandatory Scheme Pays”: A beneficiary will be able to direct a pension scheme administrator to pay the IHT due on the pension benefit (plus any interest due) direct to HMRC from their benefit if the IHT due on the benefit is £4,000 or more provided the tax is not more than the relevant chargeable benefit due from the scheme and any requirements prescribed by HMRC are met (yet to be published).

The tax must be paid within three weeks of a valid instruction.

“Voluntary Scheme Pays”: A pension scheme administrator will have the discretion to agree to a request from a beneficiary to pay IHT direct to HMRC from their benefit if the IHT due on the benefit is less than £4,000 provided the other requirements for Mandatory Scheme Pays are met.

Supporting members

The changes being made are complex. Trustees will want to ensure their administrators are prepared to make the necessary updates to their processes ahead of April 2027. We can help you streamline your existing processes in preparation for the new regime.

Trustees will need to update their scheme documents and communications to ensure they reflect the new rules and may also want to provide additional proactive communications to highlight the changes to members and decisions they will need to make under the new regime.

Members who might be affected by the changes should seek financial advice to consider their own circumstances. We can help pension schemes prepare for possible changes that members may wish to make.

Employers will need to ensure their communications are up to date and may want to check that trustees will have the communications, systems and processes updated ahead of April 2027 to avoid reputational issues arising from the new regime.