Your Guide to Pension Inheritance Tax Payments

From April 2027, Inheritance Tax (IHT) will apply to pension death benefits. This change makes it important to review estate plans and understand how tax may impact your beneficiaries. Knowing the ways IHT can be paid on pension funds helps ensure a smoother process for all involved.

 

How pension Inheritance Tax will be managed

Instead of pension scheme administrators handling the reporting and payment of IHT, the responsibility now lies with the personal representatives (PRs) of the deceased. HMRC has set out three main ways to settle IHT on pension funds, each with similar tax outcomes but different practical considerations.

When someone passes away, personal representatives will:

• Notify each pension scheme where the deceased held benefits
• Receive a valuation of those benefits and confirm who is entitled to them, including proportions for exempt and non-exempt beneficiaries
• Include the pension in the estate’s IHT reporting
• Inform beneficiaries and pension schemes of the IHT due on each share

Both personal representatives and beneficiaries are jointly responsible for any IHT arising from pension benefits.

 

The three payment options

If no IHT is due, the personal representatives will confirm this to the pension scheme administrator, who can then release the death benefits to the beneficiaries in the chosen form (for example, lump sum, drawdown, or annuity).

Where IHT applies, there are three possible payment routes:

 

1. Paying from the free estate

Personal representatives may choose to pay IHT from the estate itself. This allows probate to proceed quickly. If a pension beneficiary does not also inherit from the estate, representatives can request reimbursement for the portion of IHT relating to their pension share.

If the beneficiary inherits from both the estate and the pension, IHT can be deducted from the estate share, leaving the pension intact. Taxable pension beneficiaries may also receive income tax relief for any IHT paid.

 

2. Paying directly from the pension – the Direct Payment Scheme (DPS)

Under the Direct Payment Scheme, the pension scheme pays the IHT directly to HMRC before benefits are distributed. This reduces the pension value subject to income tax.

The scheme must accept instructions for payments over £4,000, though smaller amounts may be accommodated. This option is only available for UK pensions; overseas pensions require an alternative method.

 

3. Beneficiaries paying the Inheritance Tax directly

Beneficiaries may opt to pay IHT themselves, either from their own funds or by withdrawing from the inherited pension. Where the pension is taxable, income tax on the amount used to settle IHT can later be reclaimed.

 

Who decides how Inheritance Tax is paid?

From April 2027, personal representatives are responsible for reporting and paying any IHT due on pension death benefits. They can instruct pension scheme administrators to withhold up to 50% of taxable benefits for up to 15 months to cover the liability. Beneficiaries cannot require representatives to use the estate to pay their share but can request it. Beneficiaries may also choose to use the Direct Payment Scheme or pay the tax themselves.

 

Choosing the right approach

Although all three options produce broadly the same tax outcome, the practical implications can differ.

• Paying IHT from the free estate may speed up probate but can involve additional administration if reimbursement is required.
• The Direct Payment Scheme avoids the need for reimbursements and income tax reclaims, providing a smoother process overall.
• Paying personally may suit those who prefer to preserve more of their pension fund or who have sufficient liquid assets to cover the liability directly.

 

Key points to remember

The new IHT rules on pensions may evolve before 2027, but clients should review their pension death benefit nominations now to ensure they remain aligned with their wishes. This will make it easier for pension scheme administrators to exercise discretion and for personal representatives to manage the process efficiently.

It is also important to remember that IHT must generally be paid within six months of death to avoid penalties and interest, so handling these matters quickly is essential.

 

Get in touch

At Rosebridge, we can help you understand how these changes may affect your estate plans and ensure your nominations and arrangements remain appropriate. To discuss your situation or future planning in more detail, please get in touch.

Ramsbottom office: Email enquiries@rosebridgeltd.com or call 01204 300010
Chester office: Email enquirieschester@rosebridgeltd.com or call 01244 569141
Leeds office: Email enquiriesleeds@rosebridgeltd.com or call 0113 243 7100