The tax is apportioned, not the nil-rate band
In the original proposals, the government stated that the deceased’s IHT nil-rate band (NRB) would be apportioned across the estate and pension. For example, if the pension amounted to 50% of the total assets, the pension would benefit from 50% of the available NRB.
However, a subtle change to the final rules means that it is now the tax bill that will be apportioned, rather than the NRB. This change means that where the residence nil-rate band (RNRB) is available, this is effectively apportioned as well.
For example, consider a £400,000 estate benefitting from the RNRB alongside a pension of £200,000 – total assets of £600,000.
Once the NRB of £325,000 and RNRB of £175,000 are deducted, £100,000 will be taxed, creating a 40% IHT charge of £40,000. However, when compared to the original proposals, the final rules mean far more of the tax charge will now fall onto the estate, as outlined in the tables below:
| Original Proposal | |||
| Estate | Pension | Total | |
| £400,000 | £200,000 | £600,000 | |
| 66.67% | 33.33% | ||
| NRB | -£216,667 | -£108,333.33 | -£325,000 |
| RNRB | -£175,000 | 0 | -£175,000 |
| Taxable | £8,333.33 | £91,666.67 | £100,000 |
| Tax @ 40% | £3,333.33 | £36,666.67 | £40,000.00 |
| Final Rules | |
| Estate + Pension | £600,000 |
| NRB | -£325,000 |
| RNRB | -£175,000 |
| Taxable | £100,000 |
| Tax @ 40% | £40,000.00 |
| Tax on estate @ 66.67% | £26,666.67 |
| Tax on pension @ 33.33% | £13,333.33 |
| Total | £40,000.00 |
Only an executor can use the direct payment scheme
Raising the money to pay an IHT liability can prove difficult, with high rates of interest levied when IHT is not paid within 6 months of death.
To help with this, a personal representative or pension beneficiary will be able to use the Pensions Direct Payment Scheme. This service will require the pension scheme administrator to pay the IHT (and any interest due) directly from the pension – note that a prospective personal representative cannot make the direct payment instruction
To use the service, a personal representative is defined as either an executor appointed in a valid Will or the individual named on probate/letters of administration.
Unfortunately, probate/letters of administration are not normally granted until the IHT bill is paid. This means that the direct payment service may prove little help if the deceased did not leave a valid Will naming their executor (at least until such time as the beneficiaries are decided upon).
Beneficiaries caught as well as members
It is not just pension scheme members who are in scope of IHT. When a beneficiary in drawdown dies, their inherited benefits will also be assessed in the same way as the original member.
However, when a pension which has already been subject to IHT is subject to IHT again within 5 years, HMRC have confirmed that quick succession relief will apply.
Reductions in pension asset values
HMRC have confirmed that, unlike assets in the estate, loss on sale relief does not apply to pension assets. This means that IHT will always be charged on the value of the pension at the date of death – even where pension assets have significantly changed in value before they are claimed.
This raises a risk that if not moved into cash, market fluctuations may cause the beneficiary’s IHT bill to be significantly above 40% of the pension they inherit. Unfortunately, in many instances, the death of the member will mean that there is no-one able to make investment decisions to mitigate this risk until a beneficiary is chosen.
Trusts won’t avoid IHT
When IHT on pensions was announced, some thought placing pension death benefits in trust, typically via a by-pass trust, might provide a way to avoid an IHT assessment.
Unfortunately, lump sum death benefits paid to a trust will be subject to IHT. However, nominating a trust may still offer some advantages as it can keep the funds out of a beneficiary’s estate later on.
Death in service – some are better off
From 6 April 2027, all death in service benefits will be excluded from IHT, bringing consistency between discretionary and non-discretionary schemes.
This means that members of most public sector schemes (such as the NHS) will see their death in service benefits taken out of scope of IHT, whereas currently they are assessed.
Technical commentary
The introduction of IHT on death benefits is a seismic change to the pensions industry. In many cases, careful planning will be needed to avoid unnecessary tax bills and unexpected outcomes.
Important information
Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.