Government Changes to Inheritance Tax Proposals on Pensions

1.  The Key Changes

The Government announced on 21 July 2025 important changes to its proposals for imposing Inheritance Tax on pensions, in response to the Government's consultation about this.

Some welcome changes have been made to those proposals. The Government has now stated that all lump sum death in service benefits payable under any registered pension scheme are to be free of Inheritance Tax and unaffected by the Government's changes.

Further, there is a change in who has the duty to report for the remaining death benefits under registered pension schemes, which will still be caught by Inheritance Tax under the changes.  For these, the personal representatives of deceased pension scheme members, rather than pension scheme trustees and administrators, are to be responsible for reporting and paying Inheritance Tax on such pension scheme death benefits. This is likely to relieve pension funds and their trustees, administrators and advisers of a significant regulatory burden. However, the Government plans to retain the 6 months deadline for payment of Inheritance Tax on pension scheme death benefits, so a considerable burden will be transferred to personal representatives, who are usually laymen.

2.  Pension Scheme Benefits Still To Be Caught by Inheritance Tax

The Government plans to proceed with imposing Inheritance Tax on the remaining pension scheme death benefits in relation to pension scheme members and other beneficiaries who die on or after 6 April 2027. Lump sum death benefits payable on the death of an existing pensioner or deferred pensioner are therefore to be included in the estate of the deceased pension scheme member and hence are to be potentially subject to 40% Inheritance Tax.  These include a balance of 5 years' pension benefit under a DB pension scheme where a member dies within 5 years after retirement, and lump sum death benefits payable on the death of a deferred pensioner before retirement, typically a refund of contributions made to the pension scheme. The potential for Inheritance Tax liability here is subject to the exemptions from Inheritance Tax for spouses, civil partners and charities which are considered below.

3.  Double Taxation Issue

The Government has confirmed that there will be no income tax payable on the amount of the Inheritance Tax payable on pension scheme death benefits. This seems designed to address the concern about double taxation in the original proposals. The detailed legislation will need to be checked to see how much protection against double taxation is afforded by this.

4.  Joint Life Annuities

The Government has clarified that joint life annuities will not be subject to the new Inheritance Tax charge. This is because the rights of the survivor are separate from the rights of the member under such an annuity and so the survivor's rights are not part of the member's estate. The survivor's rights are paid from the annuity directly.

5.  DC Pensions Still to be Caught by Inheritance Tax

Pension funds and death benefits under DC pension schemes will still be caught by Inheritance Tax under the Government's plans, apart from death in service benefits. The Government has confirmed that payments of pension scheme death benefits will be protected by the usual exemptions from Inheritance Tax for spouses and civil partners and for registered charities. Beneficiaries other than spouses and civil partners, such as children, cohabitees and other dependants, other relatives and friends, will, however, be caught by Inheritance Tax on the deceased scheme member's pension rights.

6.  More Individuals to be Caught by Inheritance Tax

Individuals who own substantial properties will be likely to go over the thresholds for Inheritance Tax, particularly when the value of pension scheme death benefits is aggregated with the value of such properties. Increasing numbers of people are likely to be liable to Inheritance Tax on their estates on death. The imposition of Inheritance Tax on pensions is likely to increase the proportion of illiquid assets which are subject to Inheritance Tax. Since HMRC requires payment of Inheritance Tax before beneficiaries can receive assets from a deceased's estate, beneficiaries may increasingly have to borrow money in order to pay Inheritance Tax, before they can benefit from the estate.

7.  Impact on Unexpected Deaths at a Younger Age

The new Inheritance Tax charge on pensions is likely to bear heavily in cases where an individual with significant pension rights dies unexpectedly at a relatively young age, but after having left employment.

The Government describes the new Inheritance Tax charge as applying to unused pension rights on the death of a pension scheme member. The Government asserts that this is a way of clamping down on tax avoidance, and on misusing pension schemes for Inheritance Tax planning. However, it is difficult to see how a case where an individual with significant pension rights dies relatively young and unexpectedly can be categorised as one of tax avoidance and of failing to use or spend pension rights.

8.  Disincentive on Saving

There remains a risk that the overall effect of imposing Inheritance Tax on pensions will be seen as a disincentive to save for retirement and an encouragement to overspend in retirement. From its announcements, the Government appears to consider that the UK pensions system is skewed in favour of members of DC pension schemes, to the detriment of members of DB pension schemes, and in particular members of public sector pension schemes. If this Inheritance Tax policy does reduce pension saving it will run counter to the concerns of many as to the adequacy of DC pensions for individual savers.

9.  Draft Legislation

The Government has published draft legislation to implement its revised proposals. The Government is consulting on that draft legislation, and representations may be made on that draft legislation, until 15 September 2025.