Upcoming Changes to Inheritance Tax: How Unused Pension Funds and Death Benefits Will Be Affected

This article has been written by Kelly Beattie with support from Nancy Purle. 

The Government has responded to its technical consultation and confirmed that, from 6 April 2027, most unused pension funds and death benefits will be brought within the value of a person’s estate for inheritance tax (IHT) purposes.  Draft Finance Bill measures and a policy paper have also been published with more details.  The Government’s decision to bring certain unused pension funds and death benefits payable from registered pension schemes into the scope of IHT marks a significant shift in how pensions are treated for estate planning. 

Current position

Under current law, most unused pension pots and death benefits are not considered part of a deceased person’s estate for IHT purposes.  This is because most UK registered pension schemes are structured as discretionary trusts, where the pension scheme trustees or administrators have discretion over who receives the benefits when the member dies.  As the deceased does not have a fixed entitlement to specific funds, these assets are not considered part of their estate for IHT purposes. 

This favourable treatment has generally allowed families to inherit unused pension funds without incurring tax liabilities. The policy paper sets out the government’s view that, combined with the introduction of pension freedoms in 2015 and the abolition of the lifetime allowance, this has led to pensions being used as a tax-planning tool where “individuals can accumulate unlimited tax-free savings in their pension, draw on other means to fund their retirement and leave their unused pension assets to be inherited by beneficiaries without any Inheritance Tax charge”.

What’s changing in 2027?

The scope of the reforms have changed slightly following the technical consultation.  In summary, the response confirms:

• Most unused pension funds and death benefits will be subject to IHT, with the intention of “aligning their tax treatment with other types of inherited assets and removing the incentive to use pensions as a tax-planning vehicle for wealth transfer after death”, so they are used for their intended purpose of providing retirement income.
• Personal representatives (not pension scheme administrators – which was initially proposed) will be responsible for reporting and paying IHT, but there will be a mechanism for pension scheme administrators to pay any tax directly to HMRC.
• Death in service lump sum death benefits (typically a multiple of salary) will be exempt from IHT, irrespective of whether they are paid under discretionary trust or if they are non-discretionary (like for some public service pension schemes).  This is to remove the current inconsistencies and disparity in IHT treatment between discretionary and non-discretionary pension schemes.  It also reflects the Government’s recognition that these benefits are not intended as a tax planning tool, but as a form of financial protection for families during times of loss.
• Dependants' scheme pensions from defined benefit arrangements or collective money purchase arrangements to a spouse, civil partner or registered charity will remain exempt from IHT.

What this means for…

Beneficiaries

While the exclusion of death-in-service benefits is a welcome relief, the broader inclusion of unused pension pots and death benefits introduces new complexities, with beneficiaries becoming jointly liable with the personal representatives for paying any IHT due from the point they are confirmed as the beneficiary.

Further, the proposed changes have raised several questions about what an ‘unused’ pension fund is.  This could apply to individuals who die before reaching the minimum pension age (currently 55, rising to 57 in 2028), resulting in their pension becoming subject to IHT even though the member had no entitlement to draw their pension. 

Beneficiaries may also face double taxation on inherited pension funds (with both income tax and IHT being due), especially if the deceased was 75 or older at the time of death. We note that in the draft legislation provisions have been included which are designed to remove liability to income tax from the portion of inherited pension / death benefit which has been paid as the IHT charge

Members

Given the risk of double taxation for their beneficiaries and the fact that there are exemptions for paying dependant's pensions to a spouse or civil partner but not children, members may need to reconsider their estate planning and beneficiary nominations.

As our colleague, Alice Honeywill, previously highlighted small self-administered schemes (SSASs) and self-invested personal pensions (SIPPs) are commonly used by business owners, executive boards and the self-employed who may be able to invest more into their pension savings than others.  As these arrangements will also be caught by the IHT changes, further thought will need to be given to whether they remain suitable arrangements.

Personal representatives (PRs)

It had originally been proposed that pension scheme administrators would be responsible for reporting and paying any IHT due on pension funds.  This was due to the potential difficulties in PRs accessing sufficient funds within the estate to pay any IHT attributable to pension funds.  However, it will now be the PRs who must report and pay the IHT, working closely with the beneficiaries and the pension scheme administrators. The response document sets out how the process will work at a high level, but HMRC is continuing to work with the industry to refine the process. 

Rachel Pinn, Head of Probate at Burges Salmon has considered the practical implications of these changes on PRs in her article New IHT Legislation & Pensions: A further focus on the position of Personal Representatives. 

Pension scheme administrators (PSAs)

PSAs will be required to share information with the PRs (in some cases, within four weeks of being notified of death) including the split of benefits between exempt beneficiaries (such as spouses and civil partners) and non-exempt beneficiaries, and the value of all relevant unused pension funds as at the date of the member’s death.  In recognition of some of the difficulties faced by PRs, beneficiaries can direct PSAs to pay the IHT due on pensions to HMRC directly without there being additional tax implications (like income tax or unauthorised payment charges).  This places an additional burden on PSAs.

The government says that most estates will continue to have no IHT liability after these changes.  However, this does not detract from the impact on those who are affected, including the additional administration required, the potential delays in trustees being able to pay pension benefits on the death of a member and the potential liability for errors.

Next steps

The deadline for responses to the technical consultation on the draft legislation to implement the changes is 15 September 2025. There is also draft legislation to come in relation to changes to information sharing regulations “to provide the right framework to allow PSAs and PRs to exchange all of the necessary information for Inheritance tax purposes and Income Tax if due on inherited pensions”.

The consultation response promises that HMRC will publish further guidance tools and process maps to support PRs, PSAs and beneficiaries with the process for reporting and paying IHT due on the pension element of the estate ahead of the 2027 implementation.

Burges Salmon has a unique combination of pensions, regulatory and private wealth expertise.  If you would like to discuss these measures further, please contact either Kelly Beattie or your usual contact in the Burges Salmon Pensions and Lifetime Savings Team.