The Autumn Budget announced that from 6 April 2027, the majority of death benefits paid from registered pension schemes (whether DB or DC) will form part of the deceased member’s estate for inheritance tax (“IHT”) purposes. The government is consulting on the proposals until 22 January 2025. It will publish a response and carry out a further consultation on draft legislation implementing the proposals later in 2025.
What’s the current position?
Registered occupational pension schemes can pay the following death benefits:
- Dependants’ scheme pensions
These are pensions paid to a dependant such as the member’s spouse or child. They do not form part of the member’s estate and are not therefore subject to IHT. However, each pension payment is subject to income tax at the recipient’s marginal rate. Dependants’ scheme pensions are typically payable from DB schemes. - Unused drawdown funds
These may be payable where a DC scheme allows members to designate their pot for drawdown. They do not form part of the member’s estate for IHT purposes. They may be subject to income tax at the recipient's marginal rate depending on various factors including the age of the member when they died, how long it takes to put the benefit into payment, and whether drawdown payments had been made to the member before 6 April 2015. Most occupational pension schemes do not offer members a drawdown facility. - Lump sum death benefits
Where the trustees decide to whom the lump sum is to be paid, the benefit does not form part of the member’s estate for IHT purposes. However, where the trustees do not have discretion, e.g. they are required to pay the benefit to a person nominated by the member, the benefit is likely to form part of the member’s estate for IHT purposes. The member’s personal representatives (“PRs”) are responsible for reporting and paying any IHT due.Irrespective of whether the benefit is subject to IHT, if the member died aged 75 or over or the benefit exceeds the member’s available lump sum and death benefit allowance (“LSDBA”), it is also subject to income tax at the recipient’s marginal rate. The scheme is responsible for reporting and paying any income tax due. Lump sum death benefits are paid by both DB and DC schemes.
What’s changing?
From 6 April 2027, the IHT treatment of death benefits paid by registered occupational pension schemes will change as follows:
- Lump sum death benefits
Almost all lump sum death benefits will form part of the member’s estate for IHT purposes, regardless of whether they are paid at the trustees’ discretion. (The one exception is a charity lump sum death benefit.) Income tax will continue to be payable on lump sum death benefits if the member dies aged 75 or over or their LSDBA is exceeded, in addition to any IHT payable. - Unused drawdown funds
Unused drawdown funds will likewise form part of the member’s estate for IHT purposes. Income tax will continue to be payable if applicable, in addition to any IHT payable. - Dependants’ scheme pensions
Dependants’ scheme pensions will remain outside the member’s estate for IHT purposes. Each pension payment will continue to be subject to income tax.
Will IHT always be payable?
No. Whether IHT is payable depends on the total value of the member’s estate and the availability of any exemptions. In particular, the first £325,000 of an individual’s estate is exempt from IHT (the “nil-rate band”). In addition, no IHT is payable on assets inherited by an individual’s spouse or civil partner. However, IHT is payable on transfers between couples who are not married or in a civil partnership.
Who will be responsible for reporting and paying any IHT due?
Schemes will be responsible for reporting and paying any IHT due on death benefits. To enable this, new obligations will be placed on schemes and on PRs as follows:
- The member's PRs will be required to notify the scheme of the member’s death and request details of any death benefits payable.
- Schemes will be required to send the PRs details of any death benefits payable which fall within the member’s estate for IHT purposes (i.e. any lump sum death benefits and unused drawdown funds payable). It is not clear from the consultation how much time schemes will have to do this, but the consultation suggests it could be as little as two months from the date the PRs notify the scheme of the member’s death. The consultation also seems to suggest that schemes will have to send PRs not just details of the benefits (e.g. "a lump sum of £x is payable"), but in addition details of to whom they have decided to pay the benefits.
- The member’s PRs will be required to calculate how much of the IHT nil-rate band is to be apportioned to the relevant death benefits and inform the scheme of this. HMRC will develop an online calculator to assist PRs. It is not clear from the consultation whether PRs will be responsible for deciding whether any of the other exemptions and reliefs from IHT apply, or whether schemes will have this responsibility.
- The scheme will be required to use the information provided by the PRs to calculate how much IHT (if any) is due on the relevant death benefits and to report and pay this to HMRC using the existing Managing Pension Schemes service and Accounting for Tax return.
IHT must be paid within six months of the end of the month in which the member’s death occurred. Interest then starts to accrue on any unpaid IHT. Under the government’s proposals, schemes will be liable for the interest payable on any IHT due on death benefits which is not paid by the six month deadline, including in circumstances where the scheme did not know of the member's death. HMRC is requesting views on how the various deadlines for provision of information between the relevant parties and the payment of both IHT and income tax will interact.
What does this mean for trustees and employers?
Trustees
Trustees will need to ensure that their processes and communications around death benefit decision-making are updated from April 2027 to reflect the new requirements. The six month deadline for the payment of any IHT due will mean that trustees will need to obtain all relevant information around potential beneficiaries and the extent to which death benefits are subject to IHT as soon as possible. Given that currently schemes generally have up to two years to decide on distribution of death benefits, this is likely to require a significant overhaul to information-gathering and decision-making processes. Changes to scheme administration contracts may also be necessary to reflect the additional administrative burden associated with the changes.
In addition, trustees may wish to consider sending out a communication to members informing them of the changes and reminding them of the importance of keeping their death benefit nomination forms up to date. Trustees may also want to remind members that IHT is not payable on transfers between spouses and civil partners but is payable on transfers between couples who are not married or in a civil partnership.
Employers
Employers may wish to consider whether there are more tax-efficient ways of providing death in service benefits than under a registered pension scheme. The government’s consultation document says that “life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the changes”. However, it is not clear exactly what products this is referring to and whether, for example, excepted group life policies, other fully insured death in service benefits, or unfunded uninsured promises to pay a lump sum on death will be exempt from the proposals.
Next steps
As ever, the devil is in the detail. We hope to be able to fill in some of the gaps when we see the government's consultation response and the draft legislation. We expect this in 2025.
What other key pensions-related changes were announced in the Budget?
The Budget also announced changes in relation to overseas transfers and scheme administrators.
Overseas transfers
Currently, where an individual transfers their benefits under a registered pension scheme to a qualifying recognised overseas pension scheme (“QROPS”), a 25% overseas transfer charge (“OTC”) is payable on the transfer value unless one of various exemptions applies. One such exemption is that the QROPS is established in Gibraltar or a country within the EEA and the member is UK resident or resident in the EEA.
From 30 October 2024, this exemption will be removed. Where a transfer request has been made prior to 30 October 2024, the exemption will remain, provided the transfer is completed by 30 April 2025.
Trustees and administrators will need to update their scheme’s transfer processes and communications to reflect this change. In addition, trustees should contact their administrators now to confirm whether the scheme has any overseas transfers outstanding which would be affected by removal of the exemption. If it does and:
- The member requested the transfer on or after 30 October 2024, the administrator should tell the member that the OTC will apply.
- The member requested the transfer before 30 October 2024, the administrator should tell the member that the OTC will apply if the transfer is not completed by 30 April 2025.
Scheme administrators
Under the Finance Act 2004, registered pension schemes are required to appoint one or more persons to be responsible for the discharge of the functions imposed on the scheme administrator by the Act. A scheme administrator must be resident in the UK or the EEA. In many schemes, the trust deed and rules appoint the trustee(s) as the scheme administrator.
From 6 April 2026, scheme administrators will be required to be UK resident. Trustees should check who their scheme administrator is and confirm that they are UK resident. If the scheme administrator is not UK resident, the trustees will need to appoint a UK resident scheme administrator by 6 April 2026. For schemes where the scheme administrator is the trustee(s):
- If the scheme has a sole corporate trustee that is a UK-registered company, the fact that not all the trustee directors are UK resident should not present an issue.
- If the scheme has individual trustees, all the trustees will need to be UK resident from 6 April 2026 or the trustees will need to be replaced as scheme administrator by a UK resident person or persons.
