Inherited pensions

From 6 April 2027, most unused pension funds and pension death benefits will be included in an individual’s estate for inheritance tax. Under unchanged existing rules, where the pension holder dies aged 75 or over, beneficiaries will generally pay income tax when they draw inherited defined contribution pension benefits. A new clause within Finance Act 2026 is intended to stop the outcome being even worse in cases where the pension fund does not pay the IHT directly.

What is changing from 6 April 2027?

For deaths occurring on or after 6 April 2027, most unused pension funds and death benefits will be brought into the value of the deceased person’s estate for Inheritance Tax (IHT) purposes. This means that the value of such funds on death will potentially be subject to IHT at 40%.

The changes will not catch every pension benefit. The main exclusions include death in service benefits, dependants’ scheme pensions and benefits passing to a spouse or civil partner. Whether IHT is payable will still depend on the overall estate value, available exemptions and reliefs, and who receives the pension benefit.

Where can double taxation arise?

The double tax risk is most obvious where the pension member dies aged 75 or over. In that situation, the pension may first be included in the estate for IHT as mentioned above. But under existing rules where the death occurs aged 75 or over, the beneficiary will generally pay income tax when they take inherited defined contribution pension benefits. These rules are not changing. The income tax rate could be 20%, 40% or 45%, depending on their other income.

This does not mean the whole pension is always taxed twice. The position will depend on the estate, the pension terms, the beneficiary’s income tax rate and how benefits are paid. But families should be aware that both taxes may apply to the same pension value.

Why does the IHT payment route matter?

If the pension scheme pays the IHT directly, the beneficiary will usually receive pension benefits already reduced by that IHT. If, however, the beneficiary pays the IHT personally out of their own funds, or the Executors pay it and pass the cost on, the beneficiary will instead receive the full pension benefit but have already paid IHT on it.

Without a tax adjustment, the second route could leave the beneficiary paying income tax on a figure that does not recognise the IHT already suffered. That would make the outcome worse simply because of how the IHT was funded.

What does the new section 567B deduction do?

Section 567B ITEPA 2003 is the new income tax deduction rule brought in by Finance Act 2026. It broadly allows a deduction from taxable pension income where IHT attributable to the pension has been paid by the beneficiary directly, passed on to them by the Executors, or paid by the scheme administrator under the pensions direct payment process.

It does not remove the double taxation created where IHT and income tax both apply to the same pension value. But it does help ensure that the tax treatment is broadly the same regardless of how the IHT is paid, and does not unfairly penalise beneficiaries further if they have paid the IHT using funds outside of the pension scheme.

Is the process finalised?

The legislation is in place, but the detailed administration is still developing. HMRC expects to publish full guidance and details of the mechanism before the new rules take effect in April 2027.

The difference is not whether IHT applies. The difference is whether income tax is charged on the right pension figure.

Take Jane, who dies aged 79. She leaves other assets of £450,000 and an unused pension fund of £300,000. Assume her available nil rate band is £325,000, with no transferable nil rate band or residence nil rate band.

Her estate is worth £750,000. After the nil rate band, £425,000 is chargeable to IHT. At 40%, the total IHT is £170,000. If that IHT is apportioned across the estate, let’s say £68,000 relates to the pension fund.

Jane’s son, Tony, is an additional-rate taxpayer and pays income tax at 45% on the inherited pension withdrawals.

The tax could work out one of three ways:

1. If the pension fund pays the IHT, the pension available to Tony is reduced from £300,000 to £232,000. If he pays income tax at 45% when he draws it, the income tax is £104,400. He receives £127,600 net.
2. If Tony bears the £68,000 IHT personally and applies the section 567B deduction, he is no worse off than if the pension fund paid the IHT. He may receive the full £300,000 pension, but the taxable pension income is reduced by the IHT he has borne. Income tax is therefore charged on £232,000 rather than £300,000. At 45%, the income tax is again £104,400.
3. If Tony bears the IHT but the deduction is not claimed, the income tax could be calculated on the full £300,000 pension withdrawal. At 45%, that would be £135,000 of income tax, on top of the £68,000 IHT already borne. That could create an unnecessary extra tax cost of £30,600.

What should families think about now?

For pension holders, the priority is to understand whether the pension is likely to form part of a taxable estate from April 2027, and who is intended to benefit. For likely beneficiaries, the priority is to understand that inherited pension benefits may carry both IHT and income tax, and that administration after death will matter.

Useful questions include:

• are pension nomination forms up to date?
• could the pension fall into a taxable estate from 6 April 2027?
• who is likely to inherit the pension, and what income tax rate might apply?
• would the estate have enough liquid assets to fund IHT?
• might the pension scheme be asked to withhold or pay IHT after death?
• who will keep evidence of any IHT attributed to the pension value?
• who will ensure the section 567B deduction is considered when the beneficiary draws the pension?

Plan now for pension IHT and beneficiary withdrawals

The new pensions IHT rules are relevant now because they may change estate planning decisions. Pension holders may need to revisit nominations, wills, liquidity and whether pensions are still the right asset to preserve for the next generation.

The section 567B deduction itself is different. It is not something the pension holder can elect for during lifetime. It is a post-death mechanism for beneficiaries and Executors to consider once the IHT position, pension benefit and payment route are known.

The message for families is therefore twofold: plan now for the new IHT charge, and make sure likely beneficiaries understand that the income tax treatment of an inherited pension may depend on how the IHT has been paid and evidenced. For more information, please get in touch with your usual Crowe contact.