PublicSector
Could taxing unused pension funds help fill the public coffers?
From 6 April 2027, the value of unused pension funds becomes liable to inheritance tax. Here, we explore how it will work in practice and some of the challenges it throws up
Words Rachel Willcox Illustration iStock
“Nothing is certain except death and taxes.” US statesman Benjamin Franklin’s quote from 1789 may have been referring to life’s inevitabilities but, in the world of tax, there are few things less popular or more emotive than inheritance tax (IHT).
When the UK government announced in the 2024 autumn Budget that it planned to introduce IHT to pension funds and death benefits from April 2027, the backlash was inevitable.
The government will introduce legislation in the Finance Bill 2025-26 to include the value of unused pension funds and pension death benefits within the member’s estate on their death, regardless of whether the pension scheme administrators or scheme trustees have discretion over the payment of any death benefits.
The reform means that most unused pension funds and death benefits payable from a pension will form part of a person’s estate for IHT purposes from 6 April 2027. The government says this will remove distortions resulting from changes that have been made to pensions tax policy over the last decade, which have led to pensions being openly used and marketed as a tax planning vehicle to transfer wealth, rather than as a way to fund retirement.
Most UK registered pension schemes are discretionary and, under existing rules, any unused pension funds and death benefits from discretionary schemes are not subject to IHT. However, some pension schemes, such as the NHS and judicial schemes in the UK, are non-discretionary and currently subject to IHT.
Due to blended families, the pension beneficiaries may not be the same as the estate beneficiaries.
Image: iStock
Practical steps
The expected impact in terms of revenue is almost £1.5bn annually by 2030, with forecasts suggesting around £640m in the first year of operation in 2027-28, rising to £1.34bn in 2028-29.
How this will work in practice is yet to be finalised. Phil Hall, director of policy at The Society of Pension Professionals, says: “The government originally said pension scheme administrators (PSAs) would be responsible for collection and payment, which would have been an administrative nightmare.
“Thankfully they rowed back on this and have decided to keep it the same as for all other forms of IHT – i.e. the personal representative (PR) is liable. That said, the legislation has not yet been passed and there are still various issues to iron out.”
The Institute of Chartered Accountants in England and Wales (ICAEW) shares Hall’s concerns, warning that, while it did not disagree with the overall policy, it had major concerns with the way the measures are being implemented.
Katherine Ford, ICAEW technical manager for tax, says: “It means that PRs and PSAs will need to exchange information to ascertain values of multiple pensions, to apportion the nil rate band between the estate and the pensions. This will make it difficult to pay the IHT within the six-month deadline.”
Ford says the institute was concerned that more estates will suffer HMRC late payment interest, which currently stands at 8%. She adds: “Calculations will need to be reworked if lost pension pots only come to light sometime after death. There are 3.3 million lost pension pots in the UK, according to insurance industry body the ABI, and the value has risen by 60% since 2018.
“As it stands, PRs will be personally liable for paying all the IHT, including the liability on pension funds over which they have no control. Due to blended families, the pension beneficiaries may not be the same as the estate beneficiaries. PRs will need to recover the pension’s share of IHT from unco-operative pension beneficiaries and the PRs may not have the funds or the appetite to take legal action to do so. The estate beneficiaries may unfairly bear the IHT that should be borne by the pension beneficiaries.
“The measures are likely to lead to professionals declining to act as PRs, or declining to advise lay PRs, due to personal liability and the subsequent impact on the availability and affordability of professional indemnity insurance. If the PRs cannot obtain professional advice, more errors will be made on IHT returns, leading to prolonged and costly HMRC inquiries.
“Pension funds may own the sponsoring company’s trading premises and owners should be aware that there will be no APR or BPR on the value of underlying assets.”
Behavioural impact
For many households, pension pots are among the most significant assets passed down. Historically, these funds have often sat outside the taxable estate, so their potential inclusion may alter how families think about liquidity, timelines and the steps required to settle an estate.
Steve Gauke, managing director at Provira, says the proposal to bring unused pension funds and certain pension death benefits into a person’s taxable estate may result in a practical change to how some families plan for, and ultimately administer, their loved ones’ affairs.
“While details will continue to emerge as the Finance Bill 2025-26 progresses, beneficiaries and executors should look to consider a wider range of assets when preparing for estate administration,” he says.
“As with property wealth, where rising house prices have already pushed more families into tax thresholds they did not anticipate, some families may find themselves balancing meaningful inherited assets with limited cash to manage the associated costs and obligations.”
Gauke says the advice is always to prepare early. That means families should familiarise themselves with how potential changes may affect their specific circumstances, review estate plans where appropriate and seek professional advice where needed.
“Understanding the options available, whether around estate planning, financial structuring or short-term liquidity, can help ensure they are not caught off guard by additional costs or administrative requirements,” Gauke says.
Regardless of how the legislation develops, taking proactive steps now can offer reassurance. Gauke adds: “Clarity, preparation and early conversations can support families in navigating the practicalities of estate administration and managing any future changes with confidence.”
The Treasury says the decision to reform the IHT regime was one of the difficult but necessary decisions to restore economic stability, fix the public finances and support public services.
The government says it will continue to incentivise pension savings for their intended purpose of funding retirement, and estates will continue to benefit from tax reliefs on both contributions into pensions and on the growth of funds held within a pension scheme. More than 90% of UK estates will continue to have no IHT liability in 2029-30 following these changes and the reforms will only affect a minority of those with inheritable pension wealth.
The figures are set out in Table 5.1 of Autumn Budget 2024 and have been certified by the Office for Budget Responsibility.
Could taxing unused pension funds help fill the public coffers?
From 6 April 2027, the value of unused pension funds becomes liable to inheritance tax. Here, we explore how it will work in practice and some of the challenges it throws up
Words Rachel Willcox Illustration iStock