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Pensions and Inheritance Tax (IHT)

Introduction

This briefing sets out the IHT treatment of pension scheme death benefits and the importance of member nominations. 

Core considerations  

  • The interaction of pensions and IHT will undergo a marked shift in IHT treatment from 6 April 2027.

  • Until 5 April 2027, most pension scheme death benefits (whatever their form or timing) are free of IHT because the trustees or scheme administrator have discretion and choice over who they pay the benefits to. 

  • In some limited circumstances a pension scheme does not have a choice in relation to death benefit payments. These payments will be included in the estate for IHT purposes unless they qualify for an alternative IHT exemption. 

  • HMRC may decide that, in some circumstances, there has been a transfer of value for IHT purposes if a client dies within 2 years of transferring a pension between schemes.  

  • From 6 April 2027, most pension death benefits and unused pensions will be included in a client’s estate for IHT purposes. 

  • Certain pension death benefits are expressly excluded from assessment to IHT.

  • Spouse/civil partner and charity exemptions to IHT will apply to pension death benefits.

  • Pension death benefits will still be settled under pension scheme rules and not paid in line with the estate.

Contents

Where death occurs before 6 April 2027


Where death occurs from 6 April 2027

Are pension death benefits subject to IHT?

Pension death benefits can be paid in different ways - for example a lump sum, annuity or drawdown, and either before or after the deceased member has drawn retirement benefits.

Irrespective of these variables the general principle is that where death benefits are payable at the discretion of the scheme administrator and/or trustees, they will not form part of the member’s estate and so will not be subject to IHT.

This will be the case even if death benefits are payable to an individual nominated by the member, provided that the scheme administrator or trustees chose to pay to that individual and were not obligated to do so.
 

When might death benefits be assessable for IHT?

When there is no discretion in allocating death benefits then pension death benefits will form part of the member’s estate for IHT. On these occasions if other exemptions do not apply (for example the spouse’s IHT exemption) and the estate exceeds the available IHT nil rate band(s), IHT may be payable. This may happen in three specific circumstances:

  • Where the scheme rules do not provide discretionary powers in relation to the payment of death benefits

    This can happen in some occupational pension schemes (for example some statutory pension schemes such as the NHS Pension Scheme). Some older personal plans such as Section 32 buy out plans and retirement annuities may also not have discretionary death benefit powers. However certain trusts may facilitate removing the death benefits from the estate and may be a solution for some clients.
     
  • Where continuing guaranteed period annuity payments are not paid at the discretion of the scheme administrator/trustees
     
For example

If Sam dies four years after taking out a pension of £12,000 per annum increasing at 3% in payment with a 10-year guaranteed period, the pension that would have been payable to Sam will continue to be paid for the remaining six years. If the annuity provider/scheme still has discretion over who the payments are made to then these payments do not count for IHT purposes. If, however, there is no discretion (so payments must be made to the estate or following Sam’s specific instructions which can’t be varied) then these payments will form part of Sam’s estate and may be subject to IHT.  

 

HMRC has provided an IHT guaranteed annuity calculator to work out the estimated market value of guaranteed annuity payments when valuing the deceased’s estate.
 

  • Where a binding nomination directing who should receive death benefits is made by the member during their lifetime

    This removes the choice the scheme administrators or trustees have in terms of death benefits so brings them within the deceased’s estate for IHT purposes. It is for this reason that schemes generally do not offer the option of making a binding nomination unless there are no IHT consequences (i.e. death benefits payable to a bypass trust or to a member’s spouse or civil partner). However, it is technically possible that a nomination is made binding unintentionally.

     

Drawdown death benefits

Drawdown death benefits may mean that the scheme administrator has no option but to follow the member’s nomination. For example, if there are no other dependants and the sole dependant has been named by the deceased as being entitled to death benefits. In these circumstances even if the scheme pays flexi-access drawdown benefits to the dependant, HMRC takes the view that the scheme administrator has the option to pay an alternative benefit (for example a lump sum) and can decide who receives this alternative benefit. This means that the member is not treated as having made a transfer of value on death so there is no IHT consequence.
 

Transfer of value during the member’s lifetime

Making a ‘transfer of value’ during the member’s lifetime means that the value is counted towards the deceased’s estate on their death under IHT legislation. HMRC may treat a transaction as a transfer of value if the member was in serious ill-health at the time the transaction was made. In which case it does not benefit from the general protection that the IHT legislation offers.

HMRC assesses this by applying a two-year test by looking for specific transactions in the last two years prior to death which are captured on their form IHT 409. 

There are three areas that HMRC will look at:

  • Where a pension contribution was paid and the member knew they were in serious ill health
     

For example

Archie, aged 61 and knowing he is in serious ill health pays a pension contribution of £25,000 to his personal pension plan with discretionary powers in relation to death benefit payments. Archie dies 10 months later. When he made the contribution a transfer of value took place, there is no exemption under IHT legislation because he knew he was in serious ill health at the time. This means that part of this contribution will give rise to a loss to his estate which can be assessed, and this loss will be a chargeable lifetime transfer. 

If, at the time of making the contribution, Archie did not know he had health issues even if he died 10 months later then the exemption under IHT legislation should apply.  

Alternatively, if Archie survived for two years after the contribution was paid then no entry would have been made on HMRC’s form IHT 409, so it is unlikely to be investigated by HMRC.  

 

  • Where transfers are made between one scheme to another and the member knew they were in serious ill health

    HMRC takes the view that the person making the transfer is surrendering their rights under the existing plan and so ends any existing trusts that apply to those death benefits. This in turn means that the member can determine what new trusts the death benefits are subject to.

    So, HMRC may well treat this as a transfer of value if the transfer had happened within two years of the date of death and the member was in serious ill health when making the transfer. This applies even if a pension transfer was between two schemes that both provide discretionary death benefits. Again, these circumstances would need to be reported on HMRC’s form IHT 409.

    If, at the time of making a transfer there were no health issues, then even if death occurs within two years the transfer should be exempt from IHT.
     
  • Where a transfer is made into a trust during their lifetime

    This might happen where someone with a retirement annuity places it in trust and then dies within two years of doing that. These circumstances are reportable on HMRC’s form IHT 409 and if the member was in ill health at the time of transferring into a trust, then they may be considered to have a transfer of value for IHT purposes.

 

Where death occurs from 6 April 2027

At the Autumn Budget 2024, the UK Government confirmed that most unused pension funds and pension death benefits will be treated as part of the deceased’s estate for Inheritance Tax (IHT) purposes from 6 April 2027. This reform removes the distinction between discretionary and non-discretionary arrangements, aligning pensions with other inherited assets. The objective is to prevent pensions being used primarily as a vehicle for intergenerational wealth transfer, rather than for retirement provision.

The following information is based on the draft finance bill 2025-26, and as such is subject to change with the final legislation: 


Which death benefits will be included or excluded from IHT

From April 2027, the majority of pension death benefits and unused pensions will be included in the estate. Certain benefits are excluded and certain exemptions will apply.

Included in the estate

Any of the following pension death benefits not left to a spouse/civil partner or charity will be included in a client’s estate:

  • Funds that purchase dependants, nominees and successors drawdown and annuities
  • Defined benefit lump sum death benefit
  • Uncrystallised funds lump sum death benefit
  • Flexi-access drawdown and drawdown lump sum death benefits
  • Annuity protection and pension protection lump sums
  • Continuing payments under a guarantee period  - visit the IHT guaranteed annuity calculator for valuing payments under a guarantee period
  • Most trivial commutation lump sum death benefits – unless paid from a dependant’s scheme pension 

This includes any of the above paid from the client’s own pensions and any pension benefits someone has inherited following the death of another. Pension death benefits that pass through nominee or successor drawdown multiple times following the death of the previous members could be exposed to IHT multiple times.

Excluded from the estate

The following pension death benefits will be excluded from the estate:

  • Any death benefits left to a spouse/civil partner
  • Dependants’ scheme pensions
  • Death-in-service benefits (if member was actively employed)
  • Joint life annuities (survivor’s rights) – even if not for the benefit of a spouse/civil partner
  • Any benefits left to a charity
  • Trivial commutation lump sum death benefits paid from a dependant's scheme pension

The spouse/civil partner exemption and charity exemption to IHT will also apply to pension death benefits. Effective planning and use of nominations can ensure benefits are not liable to IHT.

Example 1

James dies with a personal pension valued at £500,000, he has nominated his son, Joseph, to benefit in the event of his death. The scheme follows James’ nomination and allocate the full value to Joseph.

Regardless of how Joseph chooses to take the benefits, whether as beneficiary drawdown, a lump sum, or purchasing an annuity, the full £500,000 will be included in James’ estate for IHT purposes. 

If James had nominated his spouse, Susan, then regardless of how Susan chose to take benefits the £500,000 fund would be included in the valuation of the estate, but would be exempt from IHT. 

 

Example 2
 

Kira has £150,000 in flexi-access drawdown, and has nominated her spouse, John, to benefit. She is also in receipt of an annuity paying £20,000 per annum, with annuity protection. There is no discretion over the annuity, and when Kira dies the annuity protection lump sum will be paid to the estate. Kira’s will leaves all of the estate to Kira’s daughters. 

On Kira’s death the £150,000 is paid to John and exempt from IHT due to the spousal exemption. The annuity purchase price was £400,000, and a total of £180,000 has been paid so far, leaving £220,000 to be paid to the estate as a lump sum, and be exposed to IHT.

 

Are pensions settled in line with the estate?

Just because pension death benefits will be included in estates for IHT valuation purposes does not mean that pension benefits will be settled in line with the estate. 

Pension scheme rules will continue to determine how pension death benefits are settled. 

  • Schemes which provide discretion to the trustees or scheme administrators will continue to follow their existing process to determine the beneficiaries.  
  • Schemes which must pay death benefits in a prescribed manner, including settling lump sums to the estate, will continue to do so. 

It is therefore important to understand the death benefits available from pension schemes, and how those benefits are settled. Ensure that client nominations are up to date, especially for discretionary schemes as the clients will generally won’t determine who receives those benefits. For benefits that must be settled to a client’s estate ensure that a clients will clearly reflect how those benefits should be distributed.
 

Who will be responsible for settling IHT on pension benefits

It is important to understand not just what benefits are subject to IHT, but also who is liable to settle any IHT in respect of pension death benefits. Depending on the scenario, IHT liability falls on:

Personal Representatives (PRs)

  • Executors or administrators will be liable for IHT reporting for all estate and pension assets, and will be liable for settling IHT. 
  • See our article on Inheritance tax on death for more information on calculating the value of an estate on death.
     

Beneficiaries 

  • Once pension schemes determine the beneficiaries; those beneficiaries will become jointly and severally liable to IHT on their death benefit entitlement. Beneficiaries will not become liable for IHT reporting. 
  • Beneficiaries will be able to request that scheme administrators settle the beneficiaries IHT liability before they release payment to the beneficiary. 
     

Scheme Administrators

  • Exempt from any IHT reporting obligations, and as standard will be exempt from IHT liability, even where beneficiaries request a scheme administrator settle IHT for the beneficiary. Scheme administrators can become liable to IHT, but only if:
    • A beneficiary formally requests that the scheme pays the IHT, and
    • The scheme administrator fails to pay within 3 weeks.


Beneficiaries may request a Scheme administrator settle the IHT

How the Process Operates

  1. Notification of Benefit
    When a pension scheme decides to pay a death benefit, both the beneficiary and the Personal Representatives (PRs) of the deceased’s estate will be informed.
     
  2. Assessment of IHT Liability
    The PRs are responsible for determining whether the beneficiary’s share of the pension death benefit is subject to IHT. They must then notify the beneficiary of the amount of IHT due.
     
  3. Settlement Options
    The IHT liability can be settled either by the beneficiary or by the PRs. Alternatively, the beneficiary may instruct the scheme administrator to deduct and pay the IHT before releasing any funds.


Scheme Administrator’s Obligations

When a beneficiary informs a scheme administrator to settle their IHT liability the scheme administrator must pay the IHT if:

  • The tax due is £4,000 or more, and
  • The amount does not exceed the death benefit payable.

The scheme has three weeks to comply. Failure to settle the IHT within three weeks results in the scheme administrator becoming jointly liable for the IHT, including any subsequent adjustments and late payment interest.

Payments made under such a request are treated as authorised payments by the pension scheme and will not trigger unauthorised payment charges.

If the IHT due is under £4,000, the scheme administrator may choose to pay the tax voluntarily without assuming liability.

Practical considerations:

Requesting schemes to settle IHT can be advantageous where:

  • The estate includes significant pension assets but has limited liquid resources.
  • Beneficiaries lack sufficient personal funds to meet the IHT liability.
  • It is administratively easier for beneficiaries to manage, rather than having to offset their pension income tax liability – read more below. 

Schemes may face challenges in meeting IHT settlement deadlines if pension assets are invested in illiquid holdings, such as property. This may require schemes to sell assets, such as commercial property, sometimes at below market rates to free up funds to cover the IHT charge.
 

Beneficiaries may be able to offset their income tax exposure

If beneficiaries or personal representatives pay IHT in respect of a relevant pension death benefit, this could result in a beneficiary paying more income tax on that pension death benefit compared to if the scheme administrator paid the IHT directly from the pension. 

To remedy this, if a beneficiary receives taxable pension income in a tax year from a relevant death benefit, and IHT is paid in respect of that benefit, either by the beneficiary or the personal representatives, then: 

  • That beneficiary can deduct from their taxable pension income for the tax year the lesser of: 
    • The IHT actually paid, or
    • The portion of the taxable pension income attributable to the relevant death benefit.
  • If IHT paid exceeds the taxable pension income from the death benefit, then the excess is carried forward to future tax years to offset against future taxable pension income.

In practice this offset means that a pension death benefit will not be exposed to both IHT and income tax on 100% of the benefit. The outcome will mirror the situation if a scheme administrator were to deduct IHT and then only the residual fund is subject to income tax. 

Where a beneficiary draws the death benefits gradually, for example where they selected beneficiary drawdown and draw gradually from the fund, or purchased a beneficiary annuity, then the IHT paid will be carried forward into future tax years until the taxable pension income equals the IHT paid.

For example

Jane dies in May 2027 aged 82, with a pension pot of £400,000. Her son, Tom is the nominated beneficiary and opts for flexi-access drawdown. He is also the only beneficiary and personal representative of the estate.  
IHT of £100,000 is due on the pension pot, which Tom paid with funds from the estate.  

In 2027/28, Tom draws £40,000 from the beneficiary drawdown, which is fully taxable. 

His income tax exposure is reduced by the lesser of: 
•    £100,000 (IHT paid) 
•    £40,000 (taxable pension income from the death benefit) 

Tom can deduct £40,000 from his taxable income in 2027/28. The remaining £60,000 of IHT can be carried forward and used to offset future taxable pension income from the death benefits in future tax years.
 


This offset does not allow clients to reduce their other income tax exposure by the IHT paid; only the taxable pension income from a pension death benefit can be deducted.

For example

Beth dies age 70 with a fund of £200,000, IHT of £40,000 is due on the pension death benefit and is paid by Isaac (Beth’s only child and beneficiary) from the estate funds. The pension death benefit of £200,000 is paid as a lump sum free of income tax as Beth died before age 75. There is no taxable pension income in relation to the death benefit to reduce by the IHT paid. The £40,000 IHT paid cannot be used to reduce Isaac’s other income tax exposure.
 


If a scheme administrator pays IHT (or related interest) and the tax is later repaid to the pension beneficiary, that repayment is classified as pension income and taxed accordingly.
 

Residence Nil Rate Band (RNRB) implications

Prior to April 2027, unspent pension funds were excluded from the calculation of the estate, meaning many individuals with high-value pensions were able to retain the RNRB. As the pension death benefits from April 2027 will be included in the estate for valuation purposes, then more estates will surpass the £2 million limit, triggering a reduction or even a complete loss of RNRB.

Read our article on Residence nil rate band for more information.
 

Pensions will not qualify for Business Relief

Certain pensions may invest in commercial, business or agricultural property within the pension wrapper. Prior to 6 April 2027 pensions are excluded from assessment to IHT, so Business Relief and Agricultural Relief is not a consideration.

From 6 April 2027, when pensions will be included in a client estate, pension assets will not be classed as relevant business property or agricultural property, so will not qualify for Business Relief or Agricultural Relief.

The full rate of IHT will apply to all pension assets not otherwise exempt from IHT, rather than any reduced rate which may apply to business property or agricultural property.

Read our article on IHT exemptions and reliefs for more information.
 

Charity lump sum death benefits

Charity lump sum death benefits paid from a pension will be exempt from assessment to IHT as transfers of value are exempt where property is given to charities. Furthermore, if 10% of the estate is left to a charity then the estate qualifies for a reduced IHT rate of 36%, rather than 40%.

From April 2027 pensions will mirror other assets, contributing to the total estate value. When considering whether 10% of estate assets have been left to charity, the pension value should be included in that calculation. The assessment should not be based solely on assets the personal representatives have control over but also include pension values as well.

For example

Mia currently has an estate of £1m and leaves 10% of her estate to charity in her will, the remainder of her estate is left to her husband. She also has a pension valued at £1m nominated to her two sons. In order to qualify for the reduced IHT rate of 36%:

Before 6 April 2027
Net Estate value £1.0m, and pension value £1.0m.
Payment to charity via will of £100,000 (10% of estate value of £1.0m)
Pension distributed as per expression of wish

After 6 April 2027               
Net Estate value £1.0m, pension value £1.0m.
Payment to charity via will of £200,000 (10% of estate value of £2.0m)
Pension distributed as per expression of wish

The contribution to charity needs to increase from £100,000 to £200,000 in order to qualify for a 4% reduced IHT rate. It also leaves a smaller legacy to Mia’s husband.

Nominating 10% of her pension to a charity may cause confusion and not have the intended outcome.

  • The personal representatives may still be obliged to allocate 10% of the total estate to charity (£200,000 in this example) along with any funds nominated to charity from the pension. This could result in more than 10% of assets allocated to charity.
     
  • Alternatively, if the will was rewritten, and the pension has 10% nominated to charity this risks that the pension may grow faster or slower than the wider estate and therefore result in less than 10% of total assets being allocated to charity, resulting in increased charity donations without a reduced IHT rate.

 

Practical considerations:

  • You should consider who is benefitting from your will and who is befitting from your pension to see if any adjustments may be required to equalise benefits to meet your intentions.
     
  • There could be an issue for pension heavy estates, where they have limited wider estate assets to cover the 10% allocation to charity. Personal representatives don’t have access to the pension and are otherwise unable to instruct the scheme administrators how to settle pension benefits. 

 

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