IHT AND PENSIONS – FURTHER CLARITY AND PROCEDURAL UPDATE

The announcement in last October’s Budget that ‘unspent pension funds’ would be in scope for inheritance tax (IHT) from April 2027 has caused considerable reflection and unease about the future strategy for transferring accumulated wealth. On 21 July 2025 draft legislation was published (Reforming Inheritance Tax — unused pension funds and death benefits – GOV.UK) together with a summary of the responses to the technical consultation issued last October (Inheritance Tax on pensions: liability, reporting and payment — Summary of responses – GOV.UK) that addresses some of the uncertainties included in the original detail, but the underlying drive to include these pensions as part of an individual’s IHT liability remains unaltered.

Death-in-service benefits

It was not clear in the documentation issued in connection with last October’s Budget as to whether pension death-in-service (DIS) benefits were to be included in an individual’s IHT liability calculation even though the phrase ‘unspent pension funds’ had been used – DIS benefits are clearly not unspent pension savings. The technical consultation document that considered how the changes were to be implemented was ambiguous on this point which led to respondents seeking clarification. The inference was that there would be inconsistent treatment of DIS benefits written under pension scheme rules as opposed to those held in non-pension trust structures.

The government has therefore agreed that to bring DIS benefits into scope for IHT would not be appropriate as part of the broader aim of stopping pensions being used as intergenerational tax planning vehicles. Therefore, from 6 April 2027, all DIS benefits payable from registered pension schemes will be out of scope for IHT.

Collection and reporting of IHT from pension schemes

The problem with the original proposal

The technical consultation document detailed pension scheme administrators (PSA) being responsible for the reporting and paying of IHT arising in connection with an individual’s pension savings. This was opposed by the majority of respondents because:-

• Pensions with no IHT liability would be pulled into the process – this would impact more than 160,000 estates with inherited pension wealth where no IHT would be due.
• Payments to beneficiaries could be delayed by PSAs until uncertainty over the IHT position is resolved with the personal representatives (PR) – this could affect vulnerable beneficiaries and/or lead to financial hardship.
• Determining the IHT position may often not be possible in many cases before the six-month HMRC deadline expires. To avoid incurring late payment interest charges, PSAs might therefore deduct 40% (the maximum) and would even include pensions where no IHT was due leading to significant additional administration for PRs, PSAs and HMRC in establishing the correct position for individuals.

The revised proposal

• The government has therefore dropped the original proposal so that the PRs will now be responsible for the reporting and paying of IHT arising in pension savings.
• PRs will be required to notify PSAs of a scheme member’s death.
• PSAs will be required to share the value of any unused pension funds or death benefits with the PR within four weeks of receiving notification of the member’s death.
• PRs will collect information from each PSA and other components of the estate to obtain a total valuation and thus determine whether any IHT is payable.
• Beneficiaries will become jointly and severally liable for any IHT due from the date that they are appointed.
• PSAs will need to make the liability position clear and explain to non-exempt beneficiaries (i.e., not spouses or civil partners) that IHT may be due on their pension benefits, how they can access the benefits and options for paying any IHT.

The mechanics

PRs and pension beneficiaries will have several options to pay the IHT due:-

1. PRs can pay the IHT due on the entire estate, including the pension component, directly from funds in the free estate and then apply for probate.

• If the beneficiaries of the free estate and the pension beneficiaries are the same, they can then take their pension benefits in full.
• If the free estate beneficiaries and pension beneficiaries are not the same, the PRs can use their existing legal right of reimbursement from pension beneficiaries to reclaim the IHT amount paid on the pension and distribute this to the beneficiaries of the free estate.
• If pension beneficiaries take their pension benefits in full, they will be able to claim a repayment from HMRC of any income tax paid on the amount of the IHT charge on their benefits.

2. The beneficiaries can direct the PSA to pay the IHT due on their share of the pension death benefits. Using this approach, the PRs  pay the IHT due on the free estate and work with pension beneficiaries (once appointed)  to pay IHT due on the pension component.

• The beneficiaries will be able to direct the PSAs to pay the IHT due on their behalf directly to HMRC.
• PSAs will inform beneficiaries about this option and that they will be liable for any IHT due.
• If the beneficiary directs the PSA to pay any IHT due, they will then receive the remaining benefits subject to income tax if appropriate.

3. Beneficiaries take their pension benefits in full and pay the IHT due directly to HMRC

• They can contact HMRC to arrange a refund for any income tax paid on the amount of the IHT charge on their benefits.

These mechanisms will not allow PRs to access pension funds, but they will help them to access sufficient assets in the wider estate to pay the IHT due on the whole estate (including the pension component) or reduce the amount of tax to be paid before probate is granted.

The government has published draft legislation to implement the above changes with comments to be submitted by 15 September 2025.

Payment challenges

It may be difficult, for example where illiquid assets are held, to raise funds to pay the IHT due on pension savings. However, under the revised process, the PRs can pay the IHT due on the entire estate, including the pension, directly from funds in the free estate.

PRs must pay the IHT due before probate can be applied for and the assets distributed. Where there are insufficient liquid funds, there are existing mechanisms to raise funds to pay the tax including:-

• the Direct Payment Scheme, which can be used to transfer money from the deceased’s account(s) before probate is granted
• the ability to pay the IHT in annual instalments on certain assets that may take time to sell – once the first instalment (and any others due when the plan is set up) has been paid the PRs can then apply for probate.

There will be instances where these payment options won’t work. For example, there may be insufficient funds in the free estate to pay the IHT due on the pension and the pension beneficiaries are not known or have yet to be appointed. PRs and beneficiaries (where known) must make all reasonable efforts to pay as much IHT as they can before the 6-month payment deadline using one of the methods. Late payment interest will begin to accrue on any unpaid tax after the deadline.

Where it genuinely is not possible to pay the IHT due on the pension component from the wider estate, or for the pension beneficiaries to either direct the PSAs to pay or to pay HMRC directly, the PRs will be able to speak to HMRC to agree how to proceed.

So, despite representation from across the industry to try and alter the government’s thinking on including unspent pension funds within the IHT framework, the publication of the draft legislation, and the detail included in the summary of responses to the technical consultation document, confirms their intention to proceed with implementing the change in April 2027, albeit with a revised approach to the reporting and paying of IHT where it is due. Further draft legislation is awaited that will deal with the information sharing regulations.

If you have any questions, please feel free to contact the Technical Services team.

All information is based on our understanding and interpretation of applicable law and regulation.

 

 

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