IHT and pensions

From 6 April 2027, the value of most unused pension funds and pension death benefits will be included in the deceased’s estate when calculating IHT.

Here’s what’s included and excluded from the changes:

Under current IHT rules, payments to certain beneficiaries are not subject to IHT – these are called exempt beneficiaries. Spouses, civil partners and UK registered charities are generally classed as exempt beneficiaries. Where a pension death benefit is paid to an exempt beneficiary, there is no IHT liability. These exemptions will continue to apply from 6 April 2027.

Following consultation, the Government confirmed that the PRs rather than the PSA will be responsible for reporting and paying any IHT on unused pension funds.

Any IHT due in respect of unused pensions funds can be paid:

• directly from the free estate. If the pension beneficiaries are the same as the free estate beneficiaries, then the full amount of the pension death benefit will be due to the beneficiaries. If they are different, the PRs can reclaim the IHT due on the pension death benefits from the pension beneficiaries to distribute among the free estate beneficiaries to reimburse them – which could be messy and difficult,
• by using the new direct payment scheme (DPS). Here, the PRs (and the beneficiaries) can direct the PSAs to pay IHT directly to HMRC, subject to the rules.
• Alternatively, the beneficiary could take the full pension death benefit and pay the IHT directly to HMRC, discharging the PRs’ liability. This may result in an overpayment of tax, and the need for a refund – we’ve covered how this can arise in the example below.

Once the PSA appoints a beneficiary or beneficiaries, they become jointly and severally liable for the IHT from the date they are appointed. 

The DPS allows beneficiaries and PRs to instruct the PSA to pay the IHT (and any interest) due on the pension fund directly to HMRC on their behalf. This provides a critical liquidity mechanism where the estate does not have sufficient liquid assets to meet the IHT bill on newly‑included pension funds.

Where income tax is also due on the death benefits (e.g. where the member was 75 or over when they died) using the DPS allows the beneficiary to pay IHT before income tax is applied, thereby avoiding paying income tax and IHT on the same benefits. Here's an example:

Example

Walter dies aged 76 on 1 May 2027, with £150,000 of unused pension benefits. His brother Tom is the PR; he gathers all the information regarding Walter’s estate and the PSA confirms how the pension death benefits are to be distributed between exempt and non-exempt beneficiaries. Tom calculates that IHT is due on £100,000 of the pension death benefit. Income tax is also due as Walter is over 75 when he dies. The PSA decides that Tom is the sole beneficiary of Walter’s pension – so income tax is charged at Tom’s marginal rate of 40%.

If Tom takes all the pension benefits as a lump sum death benefit, it will be subject to tax at his marginal rate of 40% - so a lump sum of £90,000 would be paid (£150,000 – 40% tax of £60,000). He’ll then have to pay IHT on £100,000 of the death benefit as well – another £40,000. So that will leave him with £50,000 (£90,000 after income tax less £40,000 IHT). The overpayment of tax (£16,000) will be sorted out by HMRC as IHT and income tax are not charged on the same funds – however, this means a wait for Tom to realise the full lump sum death benefit.

However, if Tom uses the DPS, the IHT will be paid first, and income tax will only be due on the balance. In this example, £40,000 IHT will be paid from the pension, and the remaining £110,000 will be subject to income tax @ 40%, which amounts to £44,000 – so a lump sum death benefit of £66,000 will paid to him; there’ll be no wait while HMRC works out the refund and pays it. 

Once a beneficiary is appointed, they become jointly liable for the IHT. The Finance (No 2) Bill, published on 4 December 2025 covers how the government envisages the scheme working:

• the PR or beneficiary can instruct the PSA to pay the IHT though the DPS by giving them a notice to do so. Only the IHT (and any interest) attributable to the notional value of the pension property in relation to that person’s share of the death benefit can be paid under the DPS.
• the PSA must pay the IHT with 35 days of receiving the notice, unless the individual withdraws the notice (before the IHT is paid), or
• the following conditions are not, or cease to be met before the IHT is paid by the PSA.

Conditions:

• the notice specifies the amount of IHT to be paid,
• the amount specified is at least £1,000,
• the amount of tax to be paid is not more than the amount the taxpayer (PR or beneficiary) is liable for in relation to the pension benefit being paid.

Also, where some benefits have already been paid out, the notice can’t require the PSA to pay an amount of IHT that exceeds the remaining benefits held in the pension scheme.

Regulations will allow for any payment of IHT under the DPS to be an authorised payment.

Any overpayment of IHT made under the scheme will be refunded by HMRC to the PR or beneficiaries, as determined by HMRC. No refunds will be sent to PSAs.

The Finance (No 2) Bill confirms that PRs will be able to instruct PSAs to withhold 50% of the taxable pension death benefits for up to 15 months if the PR knows or has reason to believe that IHT will be due on the pension benefits.

This measure is intended to:

• Give PRs time to assess IHT liabilities
• Ensure funds are available to meet the tax due
• Prevent complications where beneficiaries withdraw funds before IHT is paid

The withholding notice will not apply to excluded benefits (see the table above) or to benefits payable to the deceased member’s spouse/civil partner or a UK registered charity (i.e. exempt beneficiaries).

While a withholding notice is in force, no non-exempt beneficiary can receive more than 50% of their entitlement to death benefits from the scheme.

Example:

Alison dies with £200,000 in pension savings. Her four children are to benefit equally, but the PR instructs the PSA to withhold 50%. So the maximum pension death benefit that can be paid to each of the four children is £25,000 while benefits are withheld.

A withholding notice is effective from the date of receipt until:

• It’s withdrawn by the PR,
• The IHT (and any interest) is paid, or
• 15 months after the end of the month in which the deceased died.

If the PSA pays death benefits in breach of the withholding notice (for example, more than 50% of the taxable pension death benefits are paid while the withholding notice is in force) they become jointly and severally liable for the IHT with the PR.

Deadlines and safe harbour

Concerns have been raised that the current six‑month IHT payment deadline is too tight when pension assets are involved. The House of Lords recommends extending this to 12 months for a transitional period to allow PRs to meet the IHT liability on pension assets while PSAs update their processes and introducing statutory safe‑harbour provisions to protect PRs from late payment interest where they can evidence that they took reasonable steps to try to meet those deadlines but that the reason for not meeting the deadline was outside their control.

Valuation issues

Where pensions hold complex assets (illiquid funds, commercial property, unquoted shares), the current four‑week valuation window is expected to be insufficient. The House of Lords recommends extending timelines and ensuring adequate guidance is available. 

The introduction of IHT on unused pension funds fundamentally alters the inheritance‑planning landscape. The addition of the Direct Payment Scheme and the power for PRs to instruct the withholding 50% of the taxable benefits provides welcome administrative support, but these reforms still present practical challenges for advisers, scheme administrators, and bereaved families.

We await the publication of the Finance Act later in the year for final details, along with the promised information sharing legislation. We also expect HMRC to confirm the guidance, support and tools they intend to put in place to assist PRs and PSAs in complying with the new requirements.