On 22 July 2025, the UK government published the long-anticipated draft legislation that will bring significant changes to how unused pension funds and death benefits are treated for Inheritance Tax (IHT). These changes are due to come into effect from 6 April 2027 and in this blog post we will outline the key takeaways, what this means for you and what you should be doing.

What is changing?

• Pensions to fall under IHT

For the first time, unused pension funds and many lump sum death benefits will be subject to IHT. This marks a radical change from the current position, where most pension pots fall outside a person’s estate for tax purposes.

This new rule applies even if the pension was never accessed.

Ultimately, this change will mean some pensions will be taxed 40% IHT.

• Death-in-Service benefits remain exempt

One important exemption: lump sums paid as death-in-service benefits will continue to be outside the IHT net, provided they are paid from registered schemes.

• Who pays the tax?

Originally, the government suggested pension providers would be responsible for calculating and paying the tax. That idea was widely rejected during consultation.

Instead, the final proposal puts the onus on the personal representatives (PRs) of the estate (i.e., executors or administrators), who must:

• Report pension-related death benefits to HMRC
• Pay any IHT due
• Co-ordinate with pension scheme administrators to determine the pension's value

PRs will have to do this within 6 months of death to avoid interest charges.

•  Information sharing: A new role for pension schemes

Pension providers will be required to notify PRs of the value of unused pension funds and any death benefits within 4 weeks of notification of death.

Pension providers are notorious for being a nightmare to get hold of so we will have to see how this develops.

The pension providers can also be asked to pay the IHT directly to HMRC on behalf of the estate or beneficiaries, though this will require written direction from the relevant parties.

What impact will these changes have?

To you

One key question many people will ask themselves is: "If my pension passes to my spouse when I die, will it be taxed?"

The good news is that interspousal transfers will remain IHT-exempt under the new rules so the pension can pass to your spouse IHT free. But this must be structured correctly.

However, where the assets pass to a "non-exempt beneficiary" e.g. a child, this is where your pension could be taxed 40% IHT.

The following example shows the effect of these changes and the position for a client before April 2027 and post April 2027:

Elisa dies aged 78 with the following:

• £700,000 in property and savings
• £400,000 unused pension pot (which he is leaving to her adult child)
• No spouse (widowed)
• No major lifetime gifts
• Not inherited any unused IHT allowances from her widow

Before April 2027 (current rules)

Taxable estate: £700,000

Pension pot: Excluded from IHT

IHT Nil Rate Band: £325,000

IHT Residence Nil Rate Band: £175,000

Taxable amount: £700,000 - £325,000 - £175,000 = £200,000

IHT due: 40% of £200,000 = £80,000

After April 2027 (new rules)

Taxable estate: £700,000 + £400,000 = £1.1 million

Pension pot: Now included in estate

IHT Nil Rate Band: £325,000

IHT Residence Nil Rate Band: £175,000

Taxable amount: £1.1 million - £325,000 - £175,000 = £600,000

IHT due: 40% of £600,000 = £240,000

Difference: Elisa’s estate pays £160,000 more in IHT purely because her pension is now taxable.

You may be asking why does all this matter. For years, pensions have been a popular estate planning tool because of their inheritance tax advantages. Clients often chose to draw down from ISAs or other IHT taxable assets first, leaving pensions untouched for their heirs.

This strategy will now need careful rethinking. Clients may no longer enjoy the same IHT shelter if they leave pension pots untouched past death.

For the Government

Initial Government figures suggest:

• Around 10,500 estates per year will now fall into the IHT net solely because of unused pensions
• Another 38,500 estates will see their IHT bills increase

The changes are forecast to raise £1.46 billion annually by 2029-30

What should you be doing now?

1. Review pension wealth

Assess how much of your pensions could realistically be unused at death, and what death benefits may be affected.

2. Revisit estate plans

Strategies prioritising pension preservation should be reconsidered. It may now make more sense to draw down pensions earlier or explore lifetime gifting.

3. Prepare for probate delays

It is very likely that the timescales for obtaining probate will rise given the increase in complexity of there being more documents, valuations, and deadlines entering the picture.

4. Review death benefit nominations

Make sure expressions of wish and beneficiary nominations are up to date.

Final thoughts

This is the most significant shift in pension taxation in over a decade. While the headline tax rate (40% IHT) is unchanged, who pays it, and how it’s reported, is changing fundamentally.

It is vital to review your IHT situation as gone are the days of only the wealthy paying Inheritance Tax. Under the new legislation, if your estate exceeds the Nil Rate Band of £325,000 then you could have an IHT liability.

With these changes taking effect from 6 April 2027, you now have just under 2 years to plan. The good thing is that with careful planning IHT can be mitigated and for different people there are different solutions, but early planning is vital as the later you leave matters, typically the less you can do.

Please contact us on 01935 848764 if you have any concerns regarding IHT.

Please note that this is drafted legislation and the final details have not yet been confirmed. 

The value of your investments can go down as well as up, so you could get back less than you invested. Your eventual income may depend on the size of fund when accessed, interest rates and legislation.