UNUSED PENSION FUNDS AND DEATH BENEFITS: NEW INHERITANCE-TAX RISKS FROM 2027
December 2, 2025
Unused Pension Funds and Death Benefits Face IHT from April 2027
Introduction
One of the biggest reforms to emerge from the 2025 Budget affects pensions: from April 2027, unused pension funds and most death benefits will be treated as part of a deceased person’s estate. This move will potentially expose them to Inheritance Tax (IHT). What was once a widely used estate-planning device may no longer be safe. This change has major implications for individuals, families and advisers - especially those with substantial pension pots, defined contribution schemes, or clients relying on pensions as a legacy vehicle.
What’s changing (with effect from 6 April 2027)
From the 2027–28 tax year onward:
- Most unused pension funds and pension death benefits (from defined contribution and similar schemes) will be included in the deceased’s estate for IHT purposes, regardless of whether the pension scheme is discretionary or non-discretionary.)
- The previous treatment, under which many pension schemes (especially those using trust-based or discretionary death-benefit mechanisms) fell outside the IHT estate, will be largely eliminated.
- As a result, where the total value of the estate (including pension funds) exceeds the IHT nil-rate band (currently £325,000 per individual - plus any additional allowances) the excess may be taxed at up to 40%.
- The existing exemptions for death-in-service benefits (from registered pension schemes) will remain. Those payments will not count toward the estate for IHT purposes.
- To assist estates dealing with potentially large tax bills and liquidity pressures, the new rules will allow personal representatives (executors/administrators) to instruct pension-scheme administrators to withhold 50% of taxable pension/death-benefit payments for up to 15 months. That withheld amount can be used to pay IHT before the balance is released to beneficiaries.
In short: pensions will no longer enjoy a special “outside-IHT” status and will, in most cases, be treated like any other asset in the estate.
Who is likely to be affected
This change impacts a wide range of individuals, but will be especially relevant for:
- Holders of sizeable defined contribution pension pots (private or workplace pensions) who die with unspent funds.
- Clients who have previously relied on pension funds to pass on wealth outside the IHT net. For example, to children or other beneficiaries. Under the new rules, such strategies may no longer work.
- Estates with a mix of assets (property, pensions, investments) which, when pensions are added, may push the total value above the IHT threshold, thereby crystallising a potential 40% tax charge.
- Personal representatives (executors/administrators) and pension-scheme administrators: both will face additional reporting, administration and potentially tax-payment duties on death.
Although not all estates will end up paying IHT after the change, industry projections suggest a material increase in the number of estates that are IHT-liable because of pension inclusion. The combination of IHT (on death) and potential income tax (on withdrawal by beneficiaries) means the effective tax rate on inherited pension funds may be “very substantial”. In some cases leading to what commentators call a “tax trap.” It will also add potential strain to executors and personal representatives, who may struggle to find liquidity to meet IHT bills unless pension-scheme administrators correctly withhold funds and unless beneficiaries understand that distributions may be delayed.
Practical Planning - What You Should Do
Given the potential impact, now is a good moment to reassess pension and estate planning. Some practical steps to consider:
- Review pension holdings and beneficiaries now. For anyone with significant pension savings, it may make sense to run projected valuations including pension pots, to see whether the total estate will exceed IHT thresholds after April 2027.
- Consider early drawdown or use of pension funds in retirement. If funds are drawn and spent (or transferred in a taxable way) before death, they should fall outside the IHT net. For some clients, especially those in good health, more aggressive drawdown in retirement may make sense as a tax-minimisation strategy.
- Revisit wills, inheritance and legacy plans. If pensions were part of a legacy plan for children or non-spouse beneficiaries, those plans may need rethinking, especially if the estate now includes pension assets, pushing the value above the nil-rate band.
- Plan for liquidity at death. Estates that include substantial pension funds may need cash or other liquid assets to meet IHT bills. Relying on pension distributions alone may delay inheritance. The new “withholding + payment first” mechanism helps, but families and executors should anticipate possible delays.
- Engage with pension-scheme administrators early. Ensure pension trustees are informed of the changes and know their new duties (and your instructions). For example, to withhold 50% if IHT is likely. Miscommunication or delay could lead to unintended tax liabilities or distribution hold-ups.
- Integrate with broader IHT planning. Take a holistic look (pensions are only one part of the estate). Review property, investments, trusts, gifts, and other assets under the new rules to reassess total exposure and planning opportunities.
Conclusion
Bringing unused pension funds and death benefits within the IHT net from April 2027 represents among the most significant changes to inheritance tax planning in decades. Pensions, long seen as a tax-efficient way to pass wealth on, will no longer enjoy a special status, and many estates may find themselves unexpectedly subject to IHT. For individuals, families, and advisers, this means it is time to act. Review pension provisions, revisit legacy plans, and ensure estates are structured in a way that minimises tax leakage while preserving flexibility and liquidity for beneficiaries.
As always, if you’d like to discuss how this affects you or your clients, or to walk through scenarios under the new regime, please get in touch via our contact page at Mosaic Chambers.
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