Applying inheritance tax to pensions: What does the new law say?

It reflects the revised approach proposed by HMRC in July, which will mean a deceased member’s personal representatives (PRs) and the relevant pension beneficiaries will be jointly and severally liable for paying any IHT that is due.

However, following push back from PR firms, the legislation will give:

• PRs the ability to require schemes to hold onto half of the benefits payable on a member’s death for up to 15 months, while the PRs work out the IHT position; and
• PRs and beneficiaries the ability to request that a pension scheme pays any IHT and interest that is due, where the total amount that is due is £1,000 or more

Now that we have the “final” legislation, trustees and providers should identify which benefits payable under their scheme will be affected and how the final rules will impact their existing processes for paying benefits following a member’s death.

What is inheritance tax?

IHT is a tax payable on the estate of someone who has died.

The rules on when it’s payable are complex, but in summary, in the 2025/26 tax year, everyone who dies has a tax-free IHT allowance of £325,000. IHT is usually 40% of the value of an estate over this allowance. Where an individual leaves their family home to a child or grandchild, this allowance may increase to £500,000.

In addition, any assets and property left to a legal spouse or civil partner are typically wholly exempt from IHT. Historically, pensions and discretionary death benefits payable under a registered pension scheme have not been subject to IHT.

Which benefits will be in scope?

The legislation confirms that IHT may be payable on:

• unused pension savings under money purchase arrangements (it appears this will include money purchase AVCs)
• a dependant’s drawdown arrangement, and
• most lump sums payable on a member’s death under DB, DC, collective DC or hybrid schemes, including a 5-year guarantee

Some benefits are specifically excluded, including:

• spouses’ and dependants’ pensions (and any trivial commutation lump sum death benefit paid in respect of these)
• a dependant’s or nominee’s annuity purchased together with a lifetime annuity payable to the member, and
• death in service benefits

As drafted, the exclusion in relation to death in service benefits will only apply where an individual was an “active member” of a scheme immediately before their death and so there is a question mark over whether this will cover life assurance only members or death in service benefits payable under a life assurance only scheme. We understand HMRC will issue guidance to clarify this.

Who is liable to pay the IHT?

The people liable to pay any IHT (and any interest) that is due are:

• the relevant beneficiary, and
• the deceased member’s PRs

Late payment interest (currently 8% per year) will be payable on any IHT not paid by the end of the sixth month after the end of the month in which a member dies.

PRs will not be liable for any IHT that is payable on unused pensions or death benefits discovered after the PR has received a certificate of discharge from HMRC (provided the failure to discover the benefit was not due to the carelessness of the PRs). However, the beneficiary will still be liable to pay any IHT that is due on any newly discovered benefits.

A scheme administrator will only be liable to pay IHT where they make a payment in breach of a “withholding notice” or fail to pay IHT on behalf of a beneficiary or the PRs when requested to do so (see below).

Where a benefit that is payable on a member’s death is subject to income tax, the amount that is chargeable to income tax will be reduced to reflect any IHT that has already been paid.

What’s the new power to require schemes to withhold benefits?

Firms that advise and, in some cases, act as PRs expressed concern about the fact that PRs could be liable to pay IHT on relevant pension benefits but not have control of the payment of those benefits.

To address this, the final legislation provides that, if PRs know that they are, or have reason to believe that they may be, liable for IHT attributable to pension property of the deceased, they can send a scheme a “withholding notice”. Where a valid withholding notice is received, trustees will (broadly) not be able to pay out more than half of the benefits to which a beneficiary is entitled for up to 15 months after the end of the month in which the member died.

The only way in which withheld benefits can be paid out before this is if:

• the withholding notice is withdrawn by the PRs, or
• all the tax attributable to the pension property of the deceased under the scheme, and any interest due, has been paid in full

Does ‘Scheme pays’ operate here?

Yes. The final legislation enables PRs and beneficiaries to require a scheme to pay any IHT and interest that is due on their behalf by issuing a “payment notice” to the scheme, where the amount of IHT plus interest that is payable is £1,000 or more.

Where a valid payment notice is issued, a scheme will have 35 days to pay the IHT and interest that is due. PRs will be able to issue a payment notice to a scheme even if they haven’t issued a withholding notice first.

What does this mean in practice?

While HMRC’s final proposals are less onerous for pension trustees and providers than those originally put forward, they will still have important practical implications for schemes and providers. In particular, schemes and providers will need to:

• identify which of their benefits are in scope under the new IHT on pensions regime
• map out their existing processes for paying benefits following a member’s death – including what happens when they are notified of a member’s death, how they identify potential beneficiaries, how they decide who will receive the death benefits (where they have discretion) and how they engage and communicate with the beneficiaries and a deceased member’s PRs
• update these processes to reflect how the new regime will work

Some of the key steps that will need to be built into a scheme’s processes moving forwards include:

• verifying the identity of a deceased member’s PRs at an early stage and before any information is given to them (this will need to be done before the PRs have obtained the grant of probate, as this is only issued once all IHT on a deceased’s estate has been paid)
• exchanging information with a deceased member’s PRs, including what benefits are payable under the scheme and who the beneficiaries are (HMRC has indicated schemes will be required to do this within 4 weeks of being notified of a member’s death)
• a mechanism for withholding 50% of the benefits payable where a valid withholding notice is received from a deceased member’s PRs – this is likely to mean schemes will need to be ready to pay out death benefits in two instalments
• a mechanism for paying any IHT and interest that is due direct to HMRC within 35 days, where they receive a valid payment notice from a beneficiary or a deceased member’s PRs, and
• issuing communications to beneficiaries to explain that IHT may be payable on the benefits they receive and that the scheme may be required to withhold up to half of the benefits for up to 15 months and outlining the beneficiary’s options for taking their benefits and paying any IHT that is due

Schemes and providers also need to consider how they will inform their existing members about these changes and how they help their members understand the tax implications, particularly where they are asking members to complete or update an expression of wishes form.

What happens next?

The Finance (No.2) Bill is due to have its second reading in the House of Commons on 16 December 2025. It is expected it will receive Royal Assent by April 2026.

The legislation extending the IHT regime to unused pensions and death benefits will apply to deaths on and after 6 April 2027. We anticipate HMRC will publish guidance on how the regime will work in practice in the run-up to this. It will also need to introduce separate legislation to implement the information sharing requirements for trustees and PRs that will underpin this new regime.

What do we think?

The legislation included in the Finance Bill attempts to strike a balance between the interests of HMRC, pension schemes, beneficiaries and PRs. While the primary responsibility for paying any IHT that is due will sit with the relevant beneficiaries and a deceased member’s PRs, pension schemes and providers will need to be engaged in this process. They will also need to have processes in place to validate and action any withholding notices and payment notices they receive.

Although the legislation in the Bill takes account of feedback HMRC received on the draft legislation published in July, several aspects of it are new. Therefore, we anticipate that it may need to be amended before it comes into force to ensure it works as intended.