Pensions and IHT: Draft legislation brings welcome clarity

Pensions and IHT: Draft legislation brings welcome clarity

For years, pensions have offered a valuable shield from inheritance tax for some, featuring heavily in some estate strategies. But from April 2027, that landscape is set to shift dramatically. Draft legislation proposes bringing most pension death benefits into scope for IHT, potentially altering the way you approach retirement and succession planning for your wealthiest clients 

With the focus back on pensions as a vehicle for retirement income, your advice can help your clients mitigate the impact of these changes without sacrificing the life beyond work they deserve. In this article, we  

• unpack the key changes,  
• explore their practical impact, and 
• highlight the opportunities you can act on today to protect client wealth tomorrow.

Key changes from the consultation at a glance: 

	Consultation	Draft Legislation
Tax payment mechanism	Proposed scheme administrator to be liable for IHT, and settle with HMRC	Liability on the personal representatives and beneficiaries. Beneficiaries can request that the scheme administrator pays IHT directly to HMRC, subject to conditions.   Brings pensions in line with other assets in the estate
Business and Agricultural Reliefs	No clear stance	Explicit exclusion from business property relief and agricultural relief
Death-in-service	Ambiguous	Clearly excluded if member was actively employed
Scope of pension assets	Focused on discretionary death benefits	Includes both mandatory and discretionary death benefits, and continuing payments after death.
Income tax relief	Not applicable	New IHT carry-forward mechanism to equalise income tax exposure regardless of who settles the IHT.

Which pensions are in scope of IHT

This treatment applies regardless of whether the benefits are paid immediately or at a later date.

	Included in IHT calculation	Excluded from IHT calculation
	Any of the following not left to a spouse/civil partner or charity:  Funds that purchase dependants, nominees and successors drawdown and annuities    Defined benefit, uncrystallised funds and drawdown lump sum death benefits    Annuity protection and pension protection lump sums    Trivial commutation lump sum, unless paid from a dependants scheme pension, in which case it is excluded.    Continuing payments under a guarantee period	Dependants’ scheme pensions   Death-in-service benefits (if member was actively employed)    Any benefits left to a spouse/civil partner    Any benefits left to a charity   Joint life annuities (survivor’s rights)

The inclusion of continuing payments under a guarantee period (term certain) brings clarity to a previously unresolved area. While the exact valuation method for these annuities is not yet confirmed, it is expected they will be assessed at market value at the date of death, in line with general IHT principles. Advisers can now better assess whether purchasing an annuity and protecting the purchase price, or term, will deliver effective solutions for clients. Pension benefits left to a spouse/civil partner continue to benefit from the existing exemption to IHT. This can allow more time to plan around any IHT implications, and combining assets and nil rate bands may help to mitigate IHT. This planning flexibility won’t be available for non-married partners or single people. Remember to encourage clients to review nomination forms regularly, especially after major life events such as marriage, divorce, or the birth of children.

Who Pays the Tax? Clarifying Liability for IHT on Pension Death Benefits

As pensions are brought into scope for inheritance tax from April 2027, advisers need to understand not just what is taxed—but who is responsible for paying it. In a change since the consultation: 

• Personal Representatives (executors or administrators) will be liable for reporting and paying IHT 
• Beneficiaries will become jointly and severally liable on their death benefit entitlement 
• Scheme Administrators can become liable—but only if: 
  • A beneficiary formally requests that the scheme pays the tax, and 
  • The scheme administrator fails to pay within 3 weeks. 

Trustees of pension schemes are explicitly excluded from liability unless they are also the scheme administrator. This protects trustees from unexpected tax bills, but places a clear responsibility on scheme administrators. 

This new rule introduces a practical mechanism for beneficiaries to request that the scheme administrator pays the IHT directly from the pension fund, rather than out of their own pocket. 

How It Works: 

1. Beneficiary notified they will receive a death benefit from a registered pension scheme. 
2. The personal representatives determine they are liable for IHT on that benefit. 
3. They can issue a formal notice to the scheme administrator requesting payment of the tax. 
4. The scheme administrator must pay the tax if: 
   • The amount is £4,000 or more, and 
   • The tax does not exceed the benefit payable 
5. The scheme has 3 weeks to comply. If they don’t, they become jointly liable for the tax. 

If the amount is under £4,000, the scheme administrator may choose to pay the tax on a discretionary basis. 

Scenario:

 

In many cases, pension death benefits are paid at the discretion of trustees, often directly to beneficiaries rather than to the personal representatives. This new process could be essential where estates hold substantial pension assets but have limited other resources. In such scenarios, the estate may struggle to cover the IHT liability from available assets and may be unable to secure a loan due to insufficient collateral. 

Allowing beneficiaries to request that scheme administrators settle the IHT directly can provide much-needed relief to personal representatives. If the wider estate beneficiaries and pension beneficiaries are not the same, personal representatives can use their right of reimbursement from pension beneficiaries to reclaim the value of the Inheritance Tax paid and distribute this to other beneficiaries. Estates may require support to understand how to ensure benefits are distributed fairly. 

 

New mechanism to equalise income tax exposure for beneficiaries who settle IHT

If beneficiaries or personal representatives pay IHT from a pension withdrawal or from the rest of the estate, this could result in them paying more income tax on pension income than if the pension scheme administrator paid the IHT directly from the pension. 

To remedy this, the government is introducing a new income tax deduction for beneficiaries who inherit pension income and also bear the burden of IHT. The deduction applies if:

• The beneficiary receives taxable pension income in a tax year. 
• That income reflects a relevant death benefit (for example,  income from a pension fund inherited on death). 
• The beneficiary (or the personal representatives on their behalf) pays IHT on that benefit by 31 January following the end of the tax year. 

The beneficiary can deduct the lower of the following from their taxable income: 

• The IHT paid on the relevant death benefit, and 
• The portion of the taxable pension income that reflects the death benefit. 

If the IHT paid exceeds the taxable pension income in that year, the excess can be carried forward to future tax years until fully used. 

Advisers can help clients time withdrawals to maximise tax efficiency. While the exact mechanism for the income tax deduction is yet to be confirmed by HMRC, it may help reduce adjusted net income and mitigate the loss of the personal allowance.   Clear documentation of IHT paid and pension income received will be essential to support claims.

Scenario:

 

Confirmation that Business and Agricultural Property Relief will not apply to pension assets

Pension assets are not classed as relevant business property or agricultural property, so do not qualify for: 

• Business Property Relief (BPR) 
• Agricultural Property Relief (APR) 

Currently this is not an issue as the pension was exempt from IHT. But after 6 April 2027, this could have significant implications for clients with pensions invested in business or agricultural assets, particularly within SSAS or SIPP structures. Business or agricultural assets might qualify for 100% or 50% relief from IHT under BPR or APR if held outside the pension. 

You may wish to review how any liability for IHT could be funded with clients who have existing arrangements of this type. As the legal personal representative is now responsible for paying any IHT due, this opens up more flexibility about how the liability can be met.  

Striking a balance between IHT planning and business needs and ownership will drive future conversations on whether these arrangements will be suitable for new investors.

Planning Opportunities for Advisers

• Ensure clarity on death benefit provisions. Consider consolidating schemes for simpler administration and greater flexibility for beneficiaries.  
   
• Explore IHT strategies such as lifetime gifting, and life assurance to reduce the wider IHT exposure. 
   
• Use trusts or charitable beneficiaries where appropriate. 
   
• Consider spousal exemptions and timing of payments. 
   
• Ensure executors understand new liabilities and recovery rights. 
   
• Advise clients and beneficiaries on income tax relief opportunities post-IHT payment. 
   
• Plan for carry-forward of excess IHT deductions.