Palwinder Hare: Early planning will help maintain scheme compliance, keep members well-informed, and provide support to beneficiaries
From April 2027, significant changes will affect how unused pension pots are treated for Inheritance Tax (IHT) purposes.
For the first time, most unspent pension funds will be brought into the IHT net, meaning that, upon a person's death, these funds may need to be reported for tax and could lead to an IHT liability.
This marks a fundamental shift from the current rules, where pension pots held within a discretionary trust are not subject to IHT. It is therefore essential for trustees and those involved in pension scheme management to familiarise themselves with these changes and take proactive measures to prepare.
Inclusion of pension pots in IHT reporting
Under the new regime, personal representatives (PRs)—those charged with administering the deceased's estate – will be required to include any unused pension funds when declaring assets for IHT purposes.
In addition to reporting, PRs must also ensure that any IHT due is paid. To facilitate this, PRs can instruct trustees to withhold up to 50% of the pension benefit for up to 15 months while the tax position is clarified. In some circumstances, trustees may be required to pay IHT directly to HMRC before releasing the balance of the pension funds to beneficiaries.
Exceptions and continuity of exemptions
Certain pension-related benefits will remain outside the taxable estate. Specifically, death-in-service benefits are excluded from IHT.
Furthermore, the standard exemptions for spouses, civil partners, and charities will continue to apply. Nonetheless, most other pension pots will lose their previous tax-free status.
Trustee responsibilities and scheme preparation
Trustees are advised to review their scheme rules, ensuring that discretionary powers are sufficiently robust to accommodate the new requirements.
Collaboration with scheme administrators will be vital to develop new procedures for managing instructions from PRs, handling requests to withhold funds, and making payments to HMRC. Trustees should also communicate these changes to scheme members, clarifying the reasons for potential delays in payments and reminding members to update their expression-of-wish forms as appropriate.
Supporting beneficiaries and communication
Given the complexity and emotional sensitivity associated with pensions and taxation, trustees should be prepared to reassure beneficiaries. Transparent and timely communication can help manage expectations and alleviate stress for families during what is often a difficult period.
Impact on member behaviour
In response to the forthcoming changes, some scheme members may alter how they use their pensions, such as opting to draw down funds earlier or modifying their retirement planning to minimise potential tax exposure. Trustees should consider the possible impact on investment strategies, particularly regarding increased demand for liquidity within default investment options.
Next steps
Trustees are strongly encouraged to begin preparations now to ensure readiness for the changes to inheritance tax rules taking effect in April 2027. Early planning will help maintain scheme compliance, keep members well-informed, and provide support to beneficiaries as these significant changes are implemented.
Palwinder Hare is a professional trustee with HS Trustees. He specialises in governance, mergers & acquisitions, covenants, funding, restructuring, commercial and transaction management.
