Background

In her first Budget as Chancellor in October 2024, Rachel Reeves announced the government’s intention to apply inheritance tax (IHT) to unspent pension pots from April 2027 onwards.

A technical consultation on the processes required to implement these changes was announced and ran from 30 October 2024 to 22 January 2025. On 21 July 2025, HMRC published its response to the consultation and draft legislation.

In November, LV= released an article on our Technical Hub describing the initial announcements and outlining outstanding questions and issues at the time. Below we give an overview of the new process for reporting and paying IHT on unused pensions and death benefits, and we cover the main updates announced by HMRC. 

What is changing and what isn’t?

The main change outlined in this consultation response is an update to where responsibility for reporting and paying any IHT due will sit. Initially, it was pension scheme administrators (PSAs) who were going to be responsible. However, feedback from the industry warned that this would lead to complications and delays as schemes attempted to work out the liabilities. Instead, it will now be the estate of the deceased and their personal representatives (PRs) who have that responsibility.

The consultation response acknowledges that some respondents from industry didn’t favour either the PSA-led model or the PR-led model. Alternatives such as a flat-rate tax charge on inherited pension wealth and policy proposals outside the IHT system were suggested. The government rejected these suggestions, saying that it was clear in its objective to bring unused pension funds and death benefits into the IHT system. It also rejected the idea of a flat-rate tax charge, saying it would be a “very different policy with very different impacts” and that it wouldn’t prevent unused pension funds from being used as a tax planning vehicle.

Transfers of assets to an exempt beneficiary, such as a spouse or civil partner, will remain exempt from IHT.

What will this new process look like?

HMRC has outlined 5 stages that PRs and the PSAs must follow for the reporting and payment of IHT on the death benefits:

Stage 1: Information Exchange

PRs identify the deceased’s pension schemes, notify PSAs of death, and confirm whether the deceased had a surviving spouse/civil partner.

PSAs begin benefit distribution processes (including discretionary trustee decisions where relevant).

Within 4 weeks of notification of death, PSAs provide PRs with the IHT valuation of unused funds and pension death benefits as at the date of death.

Once the PSA has completed its processes to determine how the benefits should be distributed, it informs the PRs how benefits are split between exempt beneficiaries (such as a spouse or civil partner) and non-exempt beneficiaries.

Stage 2 – Estate Valuation

PRs compile values from PSAs and other assets to reach a total valuation of the estate and determine whether an Inheritance Tax account should be returned to HMRC.

If an account is required, PRs give PSAs the IHT reference number and request limited identity details of pension beneficiaries for completing the account.

Stage 3 – IHT Filing and Payment

If no IHT account is required, PRs can tell the PSAs and beneficiaries (if known) and proceed to apply for probate and distribute the assets in the estate. PSAs complete their processes to determine beneficiaries and distribute benefits.

If an account is required but no IHT is due, PRs will return an account to HMRC, providing the value of the estate, including pension values and beneficiary details. They can then proceed to apply for probate and distribute the assets of the estate.

If IHT is due, PRs will establish how much Inheritance Tax is attributable to the different pension components of the estate, and submit an account to HMRC, and inform PSAs and beneficiaries of their liability.

There are then several ways that the Inheritance Tax on the pension component of the estate can be paid.

Stage 4 – Pension Benefit Distribution

PSAs and trustees will start the process of identifying and paying beneficiaries once notified of a death. Once identified, they will notify the beneficiaries of amounts and payment options (lump sum or forms of pension income).

Exempt beneficiaries can take their benefits immediately.

Non-exempt beneficiaries are informed by the PSA that IHT may be due on the pension and that they are jointly and severally liable for it with the PRs. The pension beneficiary then has options for how to pay any Inheritance Tax due.

Inherited pensions may also be subject to Income Tax, depending on the deceased’s age at death:

• Death before age 75 - usually tax-free
  
• Death at/after age 75 - usually taxed at beneficiary’s marginal rate

If the pension beneficiary directs the PSA to pay their Inheritance Tax liability, these payments will be authorised payments and will not be subject to Income Tax.

If the pension beneficiary does not direct the PSA to pay, they may end up paying Income Tax on the benefits they receive. In this scenario, they will be able to claim a refund of any overpaid Income Tax from HMRC. HMRC will publish further guidance on how this refund process will operate. 

Stage 5 – Amendments

PRs will be responsible for managing any amendments to the estate and submitting any amended IHT accounts to HMRC.

If additional IHT is due because of the amendment, PRs inform the pension beneficiaries (or PSA if the beneficiaries are not yet known), payment follows the routes set out in Stage 4 above.

If less IHT is due, the PRs actions will depend on whether probate has been granted. Generally, Inheritance Tax refunds will not be made until the deceased’s account is settled. When refunds are issued, PRs are responsible for distributing these to the appropriate beneficiaries.

Beneficiaries must contact HMRC directly if any corresponding adjustments are needed to the Income Tax due on their pension funds.

Other Main Points:

IHT late payment interest

HMRC’s response confirmed that a significant number of respondents in the consultation spoke about the IHT late payment interest charges. Currently, interest is due when IHT is not paid by the end of the sixth month after the person dies. When discretion is used, complex cases can regularly take longer than 6 months to settle.

Many respondents suggested that this deadline should be extended to 12 months or two years (to align with the two-year window for payment of pension benefits tax-free) for estates with a pension component.

Under the PSA-led process initially outlined, it was believed that many PSAs would be likely to pay 40% of the value of the pension fund value to HMRC if the IHT due wasn’t determined at the 6-month stage. This would create a significant administrative burden for PSAs, PRs and HMRC to rectify any overpayments.

The government acknowledged the widespread difficulties that their initial proposal would cause with the timescales for PSAs to pay out benefits. This was a major reason for the government’s decision to not proceed with the PSA-led process initially proposed and instead move to one led by the personal representatives.

The consultation response further stated that the government doesn’t intend to extend the deadline before interest is due under the new, PR-led process. It views the 6-month requirement as an important part of its ability to collect tax quickly and efficiently. 

Joint life annuities

One of the few types of death benefits that are out of scope is joint life annuities.

The consultation response has confirmed that, if the chosen survivor is a spouse or civil partner, the usual IHT exemption would apply. 

In addition to this, it is also confirmed that for unmarried couples and children, the rights of the survivor are separate from the rights of the member. The survivor’s rights are therefore not part of the member’s estate and are not in scope of IHT.

Guarantee periods and value protection for annuities have always been in scope for IHT where the PSA doesn’t operate discretion. However, PSAs that do operate discretion will also see them fall into scope from April 2027. It is important to note however that they will remain out of scope when paid to an exempt beneficiary.

Valuation on death

The draft legislation confirms that the IHT due is to be calculated based on the value of the pension fund immediately before death. However, as many pensions are invested in volatile assets such as shares, the fund’s value could change significantly before benefits are paid. This means beneficiaries could face an IHT charge based on a higher value than they ultimately inherit. The same risk applies to pensions invested in property or other illiquid assets, where the realised value may differ from the valuation at the time of death.

Death in service benefits

Currently, death in employer-provided death in service benefits are only subject to IHT where the pension scheme is non-discretionary.

The government’s technical consultation initially proposed that all lump sum death benefits should fall within the scope of IHT from 6 April 2027. Respondents argued this would create inconsistencies, as employers could restructure benefits through non-pension trust arrangements to avoid IHT, an option not available to many public-sector defined benefit schemes.

The government has accepted these concerns and confirmed that, from 6 April 2027, all employer-provided death in service benefits from registered pension schemes will be exempt from IHT, whether the scheme is discretionary or non-discretionary.

The exemption only applies to group schemes set up by employers and from April 2027 pension term assurance policies are still in scope to be subject to IHT.

One area that could be seen as unfair concerns members who die before age 55. Under the draft legislation, their pension benefits will still fall in scope of IHT, despite the fact they never had the opportunity to access their benefits. 

What happens next?

The government has said that they will welcome comments on the draft legislation that it has published by 15th September. LV= will be actively taking part in the consultation discussions and related HMRC workshops over the coming weeks and months and will provide further updates as more information emerges.

Comment

The changes remain in draft, and further amendments are possible. However, the consultation response makes clear the Government’s determination to bring unused pensions and death benefits within the scope of IHT.

PSAs will welcome the shift of reporting and payment responsibilities from the PSAs to the PRs. That said, PRs, often families dealing with bereavement, will face additional administrative burdens at a difficult time and are likely to need support from professional advisers such as solicitors and financial advisers.

Individuals (and their advisers) who have relied on pensions as a core element of their estate and IHT planning will need to review their arrangements to avoid unnecessary tax exposure. Overall, these changes are likely to increase the demand for high-quality, regulated advice.

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.