Inheritance Tax & Pensions: What’s changing from April 2027?
Katriona McEwan · Posted on: September 12th 2025 · read
In the Autumn 2024 Budget the government announced that from 6 April 2027, most unused pension funds will be brought into a deceased person’s estate for the purpose of inheritance tax (IHT).
This change is projected to raise £3.44bn by 2030 and significantly alter taxpayers’ behaviour vis-a-vis pensions. Up to now, pensions have been excluded from estates for IHT and have therefore formed the cornerstone of much IHT planning; with individuals accumulating large pension pots to pass on IHT free. It is the government’s intention to alter this and incentivise taxpayers to draw down on their pension to fund retirement.
In addition to the new tax charge arising on pensions, their inclusion in estates has raised the question of how the additional liability is to be funded. A question which has been the subject of a recently concluded consultation.
So, who pays?
When the policy of including pensions in IHT was initially announced, the government proposed that Pension Scheme Administrators (PSA’s) should be responsible for paying the IHT on unused pensions. HMRC issued a detailed consultation to finesse the practicalities of this approach, however, having received well over 200 responses, policy makers were forced to re-think.
Responses to the consultation highlighted that PSA’s would not have full visibility over a deceased person’s estate causing two possible issues: firstly, payment of IHT where none was due (e.g. where nil rate band or spousal exemption was available) and secondly, PSA’s would likely be cautious and make maximum payments (40% of unused pension) to avoid any late payment interest. Both scenarios would delay the payment of funds to beneficiaries and create extra administration where refunds were due.
Taking these points on board, the government have amended the approach and now propose that Personal Representatives (PR’s) will be responsible for remitting the IHT on unused pensions along with IHT arising on the rest of a deceased person’s estate.
Managing cash flow
Whilst in theory, this approach should result in beneficiaries receiving funds sooner, PR’s may be required to pay up to 40% of the value of pension funds held in a scheme within a relatively short time. The consultation response gives an outline of how PR’s and PSA’s should communicate and cooperate to make this possible, but broadly speaking the PRs and beneficiaries become jointly and severally liable to the IHT on the pension funds once these are distributed by the PSA and there are three options for payment of the IHT:
Pension funds are distributed to beneficiaries; the beneficiaries pay any IHT due to the PRs who send on to HMRC.
Beneficiaries instruct PSA’s to make a payment of the correct amount of IHT to the PRs, who have assessed the value of the remaining estate and they submit to HMRC. This mechanism is set out in some detail in the consultation response.
PRs pay the IHT due on unused pension funds from the free estate and recover from the pension beneficiaries in due course (or adjust distributions from the estate to beneficiaries to account for their share of IHT on the pension fund)
Double (if not triple) taxation
"There is the additional issue of unused funds belonging to those aged 75 or over being subject to income tax at the beneficiary’s marginal rate, when distributed from the fund."
"Some predict (hope) that the income tax charge will be abolished when pensions come within the ambit of IHT, however, there has so far been no indication from the government that this will happen. But it has been confirmed that there will be no income tax due on any pension funds used to pay IHT, so only the net pension fund paid to the beneficiary is liable to income tax."
What has also been confirmed is that “Where both Income Tax and Inheritance Tax are paid on the same pension benefits, HMRC will develop mechanisms to account for any overpayments and ensure that these are refunded to beneficiaries” (HMRC).
For example, if a beneficiary receives the full pension fund from the PSA and chooses to settle the IHT liability later (options 1 or 3 above), a pension fund of, say, £1million is subject to both 40% IHT and the PSA will be required to deduct income tax of up to 45% on the total payment to the beneficiary in the first instance.
£ | ||
|---|---|---|
Funds drawn
|
1,000,000 | |
Income tax payable on draw down of funds
|
1,000,000 @ 45% |
(450,000) |
IHT payable
|
1,000,000 @ 40% |
(400,000) |
Net receipt
|
|
150,000 |
Reclaim of income tax
|
400,000 @ 45% |
180,000 |
Total receipts
|
|
330,000 |
Relief, not repeal
Whilst the example above still results in an effective tax rate of 67% it is better than the 85% alternative with no relief but will clearly leave the taxpayer out of pocket whilst a repayment claim is processed.
Furthermore, the effective rate of IHT can still be more than 80% where the inclusion of pension funds in the estate causes the loss of the residence nil rate band.
Plan ahead now
Whilst no two estates are ever exactly the same, and the circumstances of beneficiaries may dictate how unused pension funds are drawn down, choosing to have the PSA remit IHT to the PRs and then distribute the net funds is likely to be the best solution from a cash flow perspective.
However, for most people, the best solution is likely to be not leaving a large unused pension fund subject to IHT in their estate. To this end, sensible measures may include:
Consolidating existing pensions to make planning easier and simplify things within the estate (multiple pension funds will take more time to administer)
Updating letters of wishes to utilise spousal exemptions or a trust (noting that funds would come within the relevant property regime) to ensure the funds to do not come into the beneficiaries’ estates for IHT
Drawing down on funds to make potentially exempt transfers or immediately exempt normal gifts from income
Using pensions to fund a life insurance policy to cover any IHT arising
As always, any tax planning should consider your financial plan and lifestyle goals and is best approached in tandem with a tax advisor and independent financial advisor.
MHA Can Help
We offer an integrated tax and financial planning service to guide you in navigating these IHT reforms. Our tax advisors work side by side with our team of independent financial planners at MHA Wealth for an all-encompassing service.
For assistance with any matters relating to IHT and pensions, please contact our Private Client Tax team, or your local office.
