Who will bear the burden of implementing IHT changes for pension scheme benefits?

As we await the 2025 Autumn budget, the pensions and private client world are hoping for further clarification on one significant change introduced at last year’s budget. It was announced that inheritance tax (“IHT”) will apply to unused pension funds and certain death benefits, changing the long-standing position that pension pots are generally not included within a deceased person’s estate for IHT purposes. 

Effective from 6 April 2027, most unused pension funds and certain death benefits will be counted in a deceased person’s estate and therefore potentially subject to an IHT charge. Draft legislation has been published but it remains uncertain exactly how this change will be implemented in practice.  Pension scheme administrators (“PSAs”) and personal representatives on death (“PRs”) each argued that the burden of responsibility for the reporting and payment of this liability should be placed on the other, for example, before a recent House of Lords committee enquiry. 

All involved need certainty sooner rather than later, particularly where systems and communications need updating.

Key takeaways

1. IHT at a rate of up to 40% could be charged on unused pension funds from 6 April 2027.
2. When combined with income tax paid by whoever ultimately draws down on the unused fund, the effective rate of tax on unused pensions could be 67% or more in many cases.
3. Those in marriages or civil partnerships should consider whether to nominate their spouse or civil partner to benefit from any unused pension (as opposed to, for example, their children) so as to make the most of the spouse exemption from IHT.
4. The current draft of the implementing legislation provides that PRs will be responsible for the reporting and payment of any IHT due on a deceased person’s unused pension scheme benefits, even though they won’t ever take possession of the pension assets.
5. This represents a significant departure from the usual position that PRs are generally only liable for IHT on assets of the estate which are within their control.
6. There are concerns from the private client sector that these arrangements will lead to significant difficulties in practice, particularly where those who stand to inherit from the estate are different to those who will benefit from the pension. They may also deter people from acting as PRs in the first place, as they increase the risk of personal liability.
7. PSAs will be subject to tight deadlines for providing valuations to the PRs and, if given notice by the pension beneficiary, paying IHT to HMRC on behalf of a pension beneficiary (four and three weeks respectively) under the draft legislation.
8. Pension providers and trustees should review their pension scheme rules, policies and procedures, update member communications and keep up to date with legislative developments.
9. Anyone who does agree to be an executor for friends or family (a common request for those working in the financial services industry) should ensure they have asked about or at least know how to access information on the person's pension arrangements along with their other assets. 

IHT recap

The current position is that most unused pension funds and death benefits are not subject to an IHT charge when a person dies. 

There is also no IHT on assets left to charities or to a legal spouse or civil partner on death.

However, IHT is generally charged at a rate of 40% on non-pension assets left to any other person, to the extent their value exceeds the deceased’s ‘nil rate band’ (currently a maximum of £325,000 plus an additional ‘residence nil rate band’ of up to £175,000 where certain criteria are met, totalling up to £500,000 in aggregate). The nil rate band and residence nil rate band are both “transferrable” so that a couple who are married or in a civil partnership can leave everything to each other on the first death and then the second to die can use their combined nil rate bands and residence nil rate bands to pass on up to £1m without IHT.

Most UK pension scheme members will be ‘long-term UK resident’ for tax purposes and so are within the scope of IHT on worldwide assets. Those who are not long-term UK resident (which usually means they have been tax resident in the UK for fewer than 10 tax years) are generally only exposed to IHT on assets situated in the UK (subject to various exceptions).

What is changing?

From 6 April 2027 most unused pension benefits which arise from a person’s membership of a pension scheme will be captured by the IHT net by deeming the pension assets to form part of the deceased’s estate, and therefore potentially subject to an IHT charge. 

Important concessions already agreed by the Government include that these new rules will not apply to certain pension benefits such as death in service benefits (i.e. a benefit paid where an ‘active member’ dies whilst in employment) and dependants’ scheme pensions. The pension schemes in scope under the draft legislation are registered pension schemes, ‘qualifying non-UK pension schemes’ and ‘section 615(3) schemes’.

In terms of logistics and the initial proposed interaction between PRs and PSAs, the draft legislation provides that PRs should inform the PSAs of the person’s death, and the PSAs must then confirm the value of the person’s unused pension benefits within four weeks of being notified. This value will then be included in the deceased person’s estate for IHT purposes, and the PR will make the necessary filings to HMRC and be responsible for the payment of any IHT due. 

There is generally a six month window from death to pay IHT and twelve months to file the IHT return, which is an uncomfortable fit with the two year period allowed under pension tax rules and many pension scheme rules for paying out benefits. Where the pension pays out to someone other than a PR, the PRs will theoretically have a right to recover IHT from that person but it is unclear how helpful this will be in practice if the pension beneficiary is not cooperative.

How does this impact PRs? 

PRs are legally responsible for administering a deceased person’s estate and are liable for arranging the reporting and payment of any IHT due by the estate. They will either be ‘executors’ appointed under the deceased’s will or ‘administrators’ appointed in other situations, such as where there is no will.

Whilst PRs are required to fully investigate and ascertain the estate assets and liabilities, they do not currently need to consider the IHT treatment or distribution of any unused pension benefits. 

However from 6 April 2027, PRs will need to determine what pensions a deceased held and ensure that the value of these on death is factored into the overall IHT calculation. As the draft legislation stands, the PRs will then have primary responsibility for reporting and paying any IHT due on the pension assets.

This was a welcome change for PSAs who were, under the original proposals, going to be liable as the controllers of the pension assets. Despite this being a ‘win’ for the pensions industry, the private client industry have expressed concerns with this approach, including:

• Uncertainty: because PRs will be obliged to file IHT returns and pay IHT before pensions pay out in many cases, they may not know who will benefit when they are calculating the tax due. This will be particularly significant if a spouse might benefit (such that the spouse exemption from IHT could apply).
• Practical issues: the PRs will not control the pension assets and so will generally have to fund any IHT on them from the other assets owned by the deceased on death. This could cause problems if the other assets are insufficient or are being inherited by different people to the pension assets.
• ‘Lost’ pensions risk: pensions which have not been identified or are ‘lost’ at the information gathering stage of probate and which subsequently come to light may require PRs to readjust the IHT amount due and submit relevant notices to HMRC, which might result in additional costs and time spent; or delay the normal processes as PRs look for certainty before distributing any assets.
• Difficulty obtaining pensions information: the availability of pension information to PRs may be an issue, particularly because they will not have a grant of probate at the time they are requesting that information from PSAs and so may find it difficult to prove their entitlement. There is no current proposal for the pensions dashboard to be available to PRs to trace lost pensions.
• Reluctance to act: increasing the responsibility and exposure to liability of PRs (including for assets they do not control) may result in people being unwilling or reluctant to take on the role, particularly considering that it is already onerous. Although pension beneficiaries can direct the PSA to pay IHT out of the pension assets, the draft legislation does not include this option for PRs.

How does this impact PSAs?

Whilst the draft legislation does place IHT liability initially on the PRs, there is a way in which PSAs will need to pay the IHT due on a pension scheme beneficiary’s distribution directly.

The draft legislation provides that the PSA needs to pay the IHT due directly to HMRC where a pension scheme beneficiary has given the PSA notice to do so. The PSA must do so within three weeks of notice, and there are concerns that this is not a reasonable timescale in some circumstances. In practice, PSAs may delay choosing and notifying beneficiaries until they have liquid assets sufficient to meet any IHT liability.

Further concerns expressed from the pensions industry include:

• Information sharing: technically PRs who are ‘administrators’ only have authority to act once probate is granted, so there is concern about the practicalities of dealing with requests for information. There are also concerns in some cases about sharing beneficiary details with PRs where there are family disputes and vulnerable beneficiaries. PSAs will also need to factor in volume because almost all cases will need information to be shared, even though few will statistically end up exceeding the IHT thresholds.
• Valuation changes: where PSAs do receive notice from a pension beneficiary to pay IHT, there is risk as currently drafted if the valuation of the pension assets subsequently falls and there are insufficient assets to meet the beneficiary’s IHT liability.
• Tight timescales: the timescales introduced by the draft legislation may be difficult for PSAs to meet. The deadline of four weeks given to PSAs to provide PRs with a valuation of unused pension benefits may be considered too short for schemes with illiquid assets, and the three week period mentioned above may be administratively difficult to meet.
• Spouse/unmarried partner distinction: this is familiar territory for PRs but is a new consideration for many PSAs, where pension tax rules and many scheme rules treat an unmarried partner the same as a legal spouse or civil partner. There is concern that this distinction is not well understood by many consumers and pension scheme members.  

Next steps and what to consider

As well as the concerns mentioned above, there are a number of technical points raised in response to the draft legislation. Consideration is being given to these and a government response is awaited. There have also been hearings by the House of Lords Economic Affairs Finance Bill Sub-Committee on the practicalities of implementing the policy and the concerns of both the private wealth and pensions industries. There could be updates at or following the Budget. Once the Finance Bill introducing the new legislation is passed by Parliament, there will be further regulations required for some of the detailed points. 

One point to note is that for pension scheme members who are non-UK tax resident or not long-term resident for tax purposes, there will in future be new incentives to consider certain assets, depending on whether they are excluded from IHT scope or not. 

In the meantime, action points for pension providers and trustees include:

1. Monitor developments.
2. Review your scheme rules and death benefit nomination arrangements under the pension scheme, ensuring that any member death benefit nomination forms are clear and up to date.
3. Review and update pension scheme policies, processes in anticipation of 6 April 2027 and the additional steps required.
4. Similarly, review and update customer communications ahead of the change. The contents should be clear but not give tax advice.
5. Provide training and education on the IHT changes to relevant team members.

If you would like to discuss this topic further, please contact Alice Honeywill or Edward Hayes.

This article was written by Megan Bruce, Alice Honeywill and Edward Hayes