From April 2027, pension death benefits will move firmly into the inheritance tax (IHT) net. In addition to the significant implications this has had for IHT planning generally, it has also raised questions around how IHT will be paid, and how this will interact with the existing income tax regime for death benefits – Neil Macleod, Senior Technical Manager at M&G looks at the detail.
With the Finance Act 2026 receiving Royal Assent on the 18th March there is now more clarity on how this will work in practice.
Here are the main questions answered around the IHT and income tax treatment of pensions in the new world.
Who is liable for paying the IHT on pension death benefits?
The deceased’s personal representatives (PRs) are responsible for paying any IHT due on the estate and the pension and this must be addressed as part of the normal pre-probate timeline i.e. tax paid before a grant is issued.
However, advisers need to flag a second limb of liability. Once it is known who will benefit from a particular pension death benefit, the beneficiary becomes jointly liable for the IHT attributable to that death benefit.
What are the options for paying the IHT due on the pension?
There are basically three ways that IHT can be paid in respect of the pension post April 2027.
First, the PRs can settle the overall IHT liability for both pension and non pension assets.
Where PRs pay the IHT attributable to a particular pension arrangement, they must recover that amount from the beneficiary who receives the benefit.
Second, the beneficiary can pay the IHT directly from their own assets.
Third, the beneficiary can ask the pension scheme administrator (PSA) to pay the IHT from the pension fund using the Pension IHT Direct Payment Scheme.
This is available where the IHT liability is at least £1,000 and can only be used to settle the IHT attributable to that specific scheme.
Recent legislative changes also allow PRs to instruct the PSA to withhold up to 50% of the death benefit for up to 15 months and pay any resulting IHT to HMRC.
No matter what option is used to settle the IHT due, ultimately the liability will be covered by the pension death benefit or the person in receipt of it so it is not possible to pay the IHT attributable to the rest of the estate from the pension.
What is the income tax treatment of the pension where the member dies before age 75?
Post April 2027, the income tax framework for pension death benefits continues to depend on the member’s age at death, the benefit type (e.g., lump sum vs drawdown/income), and in the pre 75 space, on whether any lump sums can be made within the member’s lump sum death benefit allowance (LSDBA).
Where death occurs when the member is under the age of 75, assuming the death benefit is settled within 2 years, there is no income tax payable where the death benefit is used to provide an income via drawdown or an annuity (dependant’s scheme pension are taxable).
On the other hand if the beneficiary opts to draw the death benefit as a lump sum (or scheme rules only provide for a lump sum), the amount in excess of the LSDBA is subject to income tax.
Post April 2027, the test against the LSDBA will be done after taking into account any IHT.
If for example, someone died with a pension worth £750,000 on which £300,000 IHT was due, £450,000 would be tested against the member’s available LSDBA.
What is the income tax treatment of the pension where the member dies after age 75?
On death post 75, all pension death benefits are subject to income tax but the route chosen for paying the IHT will ultimately drive the income tax mechanics.
If the pension scheme pays the IHT any benefits that remain are taxed under normal pension death benefit tax rules.
If the pension scheme does not pay the IHT i.e. its paid by the PRs or beneficiary, the beneficiary gets to reduce their taxable pension income by the amount of the IHT.
Take the following example:
- Pension fund: £500,000
- IHT attributable to pension: £200,000
- Member dies post 75
If IHT is paid from the pension, the £300,000 balance is taxed under the normal post 75 rules i.e., subject to marginal rate tax as drawn/paid.
If IHT is not paid directly from the pension, the beneficiary can reduce their taxable pension income by the amount of IHT paid. In our example if the £500,000 goes into drawdown, the first £200,000 of income drawn would be tax free.
The same principle applies to guaranteed annuity payments. We still await the exact details of how the tax reduction will be claimed.
In practical terms, the post April 2027 regime does not replace the existing income tax framework for pension death benefits, but overlays an additional IHT charge on top of it.
The familiar distinctions between deaths before and after age 75 remain, with IHT acting as an extra layer rather than a separate parallel system.
For those administering estate, the challenge will be less about avoiding “double taxation” and more about managing how and by whom the IHT is paid, as this directly shapes the income tax position of beneficiaries.
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