Pension Death Benefits & IHT

What the New Rules Mean

From 6 April 2027, unused pension funds and pension death benefits will form part of the deceased's estate for IHT. This applies to: unused defined contribution pension funds (including SIPPs, personal pensions, and workplace pensions), defined benefit (final salary) pension death benefits (the lump sum death benefit, typically two to four times the pension), and pension protection lump sum death benefits. The change does not apply to: pension benefits that are already in payment (the income stream itself is not an estate asset — though the value of any remaining fund may be), state pension death benefits (the state pension does not form part of the estate), and pension funds that are already crystallised and being drawn as income (to the extent they have been used to purchase an annuity). The practical effect is that anyone with a significant pension pot (over £325,000) could now face an IHT bill of 40% on their pension when combined with their other assets. Previously, a £500,000 pension could pass entirely tax-free to beneficiaries if the saver died before 75. Under the new rules, if the saver also has a £300,000 house and other assets, the pension pushes the estate well over the nil-rate band, potentially triggering a six-figure IHT bill. The pension scheme administrator will be required to report the value of the unused pension funds to HMRC and the personal representatives.

Income Tax on Beneficiaries

In addition to the IHT charge on the pension fund, beneficiaries will continue to pay income tax when they withdraw funds from the inherited pension. Under current rules, if the deceased died before age 75, beneficiaries can withdraw the pension fund tax-free (provided no benefits had been drawn). If the deceased died after 75, beneficiaries pay income tax at their marginal rate on withdrawals. From April 2027, the income tax treatment broadly continues but applies after the fund has already been reduced by IHT. This creates a double tax charge — IHT at 40% on the fund value, then income tax on withdrawals at the beneficiary's marginal rate (potentially 20%, 40%, or 45%). For example: a deceased person with a £500,000 pension and a £325,000 nil-rate band fully used by other assets. The pension suffers IHT of £200,000. The remaining £300,000 is then distributed to a beneficiary who is a higher-rate taxpayer (40%). On withdrawing the full amount, they pay £120,000 in income tax, leaving a net benefit of £180,000 from a £500,000 pension. The combined tax rate is approximately 64%. This double taxation is a significant concern and has led to widespread criticism of the policy. The government has stated that it will consult on the detailed implementation, and there is speculation that the IHT charge may be accompanied by a corresponding income tax deduction or that the double charge may be mitigated in some way. As of the 2026/27 tax year, no such mitigation has been announced, so the double charge appears to be the intended outcome.

Nomination Forms

Pension nomination forms (also called expression of wish forms) are the documents that tell your pension scheme administrator who you want to receive your pension benefits when you die. Nominations are not legally binding, but the scheme administrator will typically follow them unless there are good reasons not to. Under the current regime, nominations direct the pension fund to chosen beneficiaries, and the fund passes to them outside your estate and outside your will. From April 2027, even if the fund passes to nominated beneficiaries, it will still be counted as part of your estate for IHT purposes. However, nominations remain important because they control who receives the pension fund and how it is taxed. Nominating individuals directly (rather than your estate) means the beneficiaries can flexibly withdraw funds based on their own tax position. Nominating your estate as the beneficiary could cause the pension to be distributed via your will, potentially wasting the beneficiary's ability to manage the tax efficiently. It is essential to review and update your pension nominations regularly, particularly after the April 2027 change. Key events that should trigger a review include: marriage or divorce, birth of a child, death of a named beneficiary, and changes in the beneficiary's financial circumstances. Most modern pension schemes allow you to complete a nomination form online. Ensure you have a valid nomination on file for each of your pension arrangements.

Planning Considerations

The inclusion of pensions in the estate for IHT significantly changes the planning landscape. Here are key strategies to consider: 1. Spend your pension first in retirement — draw down your pension income before using other savings (ISAs, general investment accounts) to reduce the pension fund value at death. 2. Gifting pension withdrawals — withdraw funds from your pension, pay income tax on the withdrawal, and gift the proceeds to family. If you survive seven years, the gift falls outside your estate. This trades income tax now for IHT later and can be effective if your marginal income tax rate is lower than 40%. 3. Transfer pension to spouse — pension benefits passed to a surviving spouse or civil partner are currently not subject to IHT (spouse exemption), and this is expected to continue after 2027. The spouse can then draw the pension in their own name and manage the IHT exposure. 4. Use other IHT planning — combine pension planning with trusts, life insurance written in trust, and use of the nil-rate band. 5. Consider drawdown timing — if you are approaching age 75 and have a large pension, crystallising benefits before 75 (even if you do not withdraw the full amount) may grandfather the current IHT treatment for some funds. The government has indicated that the new rules apply to funds that remain uncrystallised at death, but crystallised but undrawn funds may also be caught. 6. Life insurance in trust — consider using a life insurance policy written in trust to provide a tax-free lump sum that pays the IHT bill on your pension. This ensures your beneficiaries receive the full value intended. Given the complexity of these rules, taking professional financial advice is essential.

Interaction with Other Assets

The inclusion of pensions in the estate has knock-on effects for other areas of IHT planning. The nil-rate band (£325,000) and residence nil-rate band (£175,000) will now need to be allocated across a larger estate, potentially exhausting them more quickly. The taper of the RNRB (for estates over £2 million) means that including a large pension in an estate that was previously below £2 million could push it over the threshold, removing the RNRB entirely. For married couples, the transferability of unused nil-rate bands between spouses becomes even more important. If one spouse has a large pension and the other does not, ensuring the first spouse's estate is structured to maximise the unused NRB and RNRB carried to the survivor is critical. Business Property Relief and Agricultural Property Relief do not apply to pension funds — they remain fully subject to IHT. However, if you hold your pension in a SIPP (Self-Invested Personal Pension) that invests in qualifying BPR assets (such as AIM shares), there is a question as to whether BPR could apply to those underlying assets. HMRC's position is that BPR is not available on pension fund assets because the pension scheme (not the individual) owns the assets. Once the fund is released from the pension to the estate, BPR does not apply because the assets are cash, not trading business assets. The government may issue further guidance on this point before April 2027.

FAQs

Do the new pension IHT rules apply to all pensions?

The rules apply to unused defined contribution pension funds (including SIPPs, personal pensions, and workplace pensions) and certain death benefits from defined benefit schemes. The state pension is not affected. Annuities that are already in payment are generally not caught, but any remaining fund value on death may be.

Can I avoid the pension IHT charge by transferring my pension to my spouse?

Transfers to a surviving spouse are covered by the spouse exemption for IHT, so no immediate IHT is due. However, the spouse inherits the pension and the pension fund will form part of their estate when they die. This defers but does not eliminate the IHT charge. It can be effective if the spouse has a lower overall estate value or can spend the pension down.

When do the new rules take effect?

The new rules take effect from 6 April 2027. The government announced the change in the Autumn 2024 Budget and has confirmed the implementation date. The rules apply to deaths occurring on or after 6 April 2027. There is no grandfathering for pensions built up before this date.

Will the pension fund be taxed twice — IHT and income tax?

Yes, under the current proposals, the pension fund is subject to IHT in the estate and then income tax when the beneficiary withdraws it. This creates a combined tax rate that can exceed 60% for higher-rate taxpayers. The government has promised consultation on the implementation, but no mitigation of the double charge has been announced as of the 2026/27 tax year.