IHT on Pension Funds: an update
20th May 2026Half of pension frozen while funeral bill still unpaid!
Endless difficulties for grieving families!
64% tax charge, as government plunders hard-earned family savings!
The internet is full of alarmist, emotional clickbait messages about the forthcoming changes under which, for the first time, any ‘unused’ pension pots will be subject to IHT. What is disturbing for many families is that, for years, they were advised not to draw too heavily on their pension savings but to exhaust other funds first. Also, having put money by over many years, they began to think that it was their money. How naive.
In my article ‘Preparing for the (next) Budget’, back in August of last year, I outlined the way the new IHT charge might operate. On 11th May H M Revenue & Customs (HMRC) published their Technical Note on the subject. It is not an easy read, but this article tries to cut through the text to highlight the most urgent points. This is not formal advice: things may yet change. I have used colloquial expressions, such as ‘pension pot’, rather than fully technical words. Here is a reminder of what is involved.
Example: Geoff and Sally
Geoffrey, 76, owns his house, worth £350,000, jointly with his wife Sally, 73. They live in the UK. Their joint savings amount to £650,000. They receive State pensions. She enjoys an occupational pension that ceases on her death. He has a SIPP containing £500,000 from which he has been drawing only a modest income, leaving the capital intact. They have made no large lifetime gifts.
They provide for each other in their wills, and joint property passes to the survivor anyway. Their children are settled in life and Geoff and Sally are now increasingly concerned for their grandchildren, mid-teens, hoping to go to college soon.
Up till 5th April 2027, IHT would not have been a major issue. On the death of the survivor of them before that date, a combined estate of £1,000,000 would probably suffer no IHT after claiming Nil-rate Band (NRB) Transferable NRB, Residence NRB and Transferable Residence NRB.
Under the new rules effective from 6th April 2027, the pension fund is included as part of the estate to be taxed. That adds £500,000 and triggers a tax charge at 40% of £200,000. Interestingly, the government have suggested that actually the average extra tax bill, following the change, would be only about £34,000. Maybe most pension funds are quite small.
There are two points to note. First, the charge to Income Tax. It was always the rule that, since tax relief had been granted on the money going into the pension pot, what came out (over and above the tax-free lump sum) would, if the pensioner had been over 75 at death, be taxed as income. So, while it might feel as if there was a tax charge of 64% (ie40% IHT and maybe 40% on what is then left), in truth the only new tax charge is the IHT.
The second point is more serious. If, say, the estates of Geoff and Sally (not counting the pension fund) had amounted to £2,000,000 exactly, then under the old rules the Residence NRB and Transferable Residence NRB would be available. The new rules push the estate up and, in so doing, in this example the Residence NRB and Transferable Residence NRB are both lost. So that is £140,000 of extra tax to find. This makes the government figures look quite unrealistic.
The Residence NRB, and Transferable Residence NRB, are both lost.
Practicalities
Who must report the values?
This is where the Technical Note from HMRC is most use. There was originally uncertainty as to how values were to be reported, and by whom. The professions lobbied parliament, anxious to make life bearable for executors. I use the term ‘executor’ to mean either a person named as such by a will or any other person dealing with the estate.
The rule is now that the executor is responsible for reporting the value of:
the ‘owned’ estate of the deceased;
any trust funds of which he was life tenant;
any lifetime gifts caught by the rules; and, from 6th April 2027,
the value of any unspent pension pot(s).
How will the executor manage all that? HMRC expect him to make full enquiries of the papers of the deceased, of his family and business associates. He is to ‘take reasonable steps to identify and pension schemes from which death benefits may be payable’. One particular area of difficulty concerns any lump sum or death benefit allowance. This mainly affects the charge to Income Tax rather than IHT. We shall learn more in due course.
The Technical Note explains that, in future, pension scheme administrators must co-operate with executors and provide valuations promptly. That is important, because IHT is due for payment around six months from the death, leaving little time to get the figures together. After that, interest begins to run on the tax debt.
After six months, interest begins to run on the debt.
Who must pay the tax, and how?
Initially, it is the executor who pays. This is where the 50% rule comes in. Clearly, an executor wants control over assets, if he is personally liable for tax on them. Without that, the job is too hot to handle. Therefore, if he sees that the estate is large enough for IHT to be an issue, he can tell the pension trustees to hold back half the fund, for the time being, and release only half to the family or other beneficiaries. Funds will not be held back from exempt beneficiaries.
This is called a ‘Withholding Notice’. The Technical Note sets out the procedure, the duration of a notice, and how it may be lifted. HMRC hope that this will not be used all the time but only where the executor knows IHT is due or thinks that it will be. I suspect that prudent executors will be fairly trigger-happy in their use of withholding notices.
A more useful document, to be used in most cases, will be the Payment Notice. As shown above, money drawn from a pension fund is usually income and taxed as such. Under the new rules, the executor can issue a payment notice to the pension administrator to pay IHT direct. This should work well: the rules provide that money paid over as IHT is not to be treated as income. The tax is ‘only’ up to 40% on the fund at that stage. (There is a rule that, where the beneficiary draws funds to pay IHT, and suffers Income Tax as a result, he may recover by set-off for IHT paid.)
Money paid over as IHT is not to be treated as income.
Exclusions and exemptions from taxation
This is important. There are rules for a Dependant’s Scheme Pension that might include spouse, civil partner or children. There is also a rule to exclude trivial commutation, affecting small funds. A joint life annuity can be an excluded benefit. Certain death in service benefits are excluded: what qualifies is described in the Technical Note.
Where property passes to a UK-resident spouse, the value is exempt. This will also apply to pension pots under the new rules. In the same way, money passing to charities or similar bodies for the public benefit will be exempt (but see below). There are some quite complicated rules in the Technical Note to ensure that spouses and charities do not suffer the IHT charge; and how gifts to charity may ‘earn’ the 36% rate of IHT.
What should prudent families do now?
Of course, I would never deter a family from taking advice from a fully-qualified adviser, but there are simple steps that every family can take.
1: Talk about it within the family
Address the issue. Prepare the family for what is likely to happen. That will help to reduce the stress after the death.
2: Keep good records
An executor should file the account with HMRC within a year of death. Keep good records. That makes life far easier for the executor. How many pensions are there? Where are the contact details for each administrator? What gifts were made in the last seven years? Are any of them exempt? Are there any crypto assets or other items that may be difficult to value?
3: Think about charitable giving
A gift in a will to charity suffers no IHT. If large enough, it can reduce the rate of IHT on the rest of the estate to 36%. A ‘gift’ made out of a pension fund suffers neither IHT nor Income Tax. Since, as seen above, there can be a 64% tax charge on receiving benefit from a pension fund in future, in many cases a gift to charity, made from the unspent pension fund, will really only cost the family only 36% of the amount of that gift. However, it seems that some pension trustees resist the idea of passing some of the pension pot to charity. Each pension fund may have its own rules.
A gift to charity might only cost the family only 36%of its value.
4: Use the existing gifts rules, for as long as they last
I described this in my last article ‘Preparing for the (next) Budget’ under the heading ‘The lifetime gifts rules (again)’ and it has been widely noted in the press. There is comment in the Technical Note: just apply the existing rules. So, draw plenty of income from the pension, then give some of it away. Regularly. Simple.
5: Buy an annuity?
This would immediately remove the ‘problem’ of an unspent pension pot. Equally, to that extent there would be nothing left for family to inherit, so overall there might be no real saving. It might make sense to use only part of the fund to buy the annuity; and certainly to try to get a good annuity rate.
6: Consider big gifts, even if you are now quite old
A strange feature of the rule that limits or excludes Residence NRB on estates over £2,000,000 is that it relates to the size of the estate at death. That includes any gifts with reservation, but not ‘failed PETs’. (For the official view on this, consult IHTM 46012.)
Example: An elderly person, with an estate of £2,300,000 freely gives away £300,000 (with no strings attached) and survives for 2 years. That gift will be added back for the overall calculation of IHT but crucially the availability of Residence NRB will be based on the figure of £2,000,000, not £2,300,000. The value given away is no longer part of the estate.
7: Move business or agricultural property out of the pension fund: build up cash
This type of business or farming asset will get no relief from IHT within a pension pot, so better to hold it personally, where the reliefs, even at the new lower levels, may apply. Equally, there is no facility for payment by instalments. It therefore makes sense to start changing what the pension fund holds, to build up cash with which to pay the tax. That could take time, so start now.
Back to the example of Geoffrey and Sally
He should start to draw more from his pension, to gradually run it down as he gets older. Around 40% of his pension fund should be in readily realisable assets, such as gilts. They should both consider cashing in some of their savings and making gifts to children and even to grandchildren. They should not delay: amid the present turmoil within the Labour Party, it is unlikely that any new leaders will want to reduce the burden of IHT on ‘wealthy’ families. A heavy lurch to the left is more likely. Hoping to live long enough to see a change to a kinder government attitude towards savings is an extremely risky strategy.
And finally: be nice to people, even tax gatherers.
I doubt if officials will read these notes, but these changes will put staff at H M Revenue & Customs, and all pensions administrators, under intense strain. Contrary to popular belief, they are human beings, and (contrary to practice in Biblical times) no doubt most are just trying to do their job. You can see how complicated it all is. Even though we have had some warning, there will not, on 6th April 2027, be enough people who know their way around the rules to deal with all the cases that arise. It will take years to train up the staff needed. There will be delays. Families will get upset at having to pay interest on tax long before its amount has even been calculated, but please treat the officials with courtesy.