Key takeaways
IHT payable on DB schemes
Most lump sum death benefits subject to IHT from 6 April 2027.
No avoidance via discretionary trust
This may affect the Trustees’ considerations on exercising their existing discretions.
Trustees must know obligations
Trustees can be required to withhold benefit payments and pay IHT.
The proposed changes
Currently lump sums will only be subject to IHT if they are paid to a member’s estate or are considered for taxation purposes to be part of their estate. On the death of a member, lump sums are usually payable from defined benefit (DB) schemes under a discretionary trust under which the Trustees may pay the monies to any one or more persons from a broad category of dependants, relatives and other persons. This keeps the lump sums out of the member’s estate for IHT purposes. It is proposed that such lump sums will become subject to IHT in relation to deaths on or after 6 April 2027 as provided in the Finance Act 2026 (the Act).
Determining the benefits that are subject to IHT
A member of a registered pension scheme will be treated for IHT purposes as beneficially entitled immediately before their death to any benefits that fall within the definition of “notional pension property” other than certain “excluded benefits”. This will bring those benefits within the scope of IHT.
The benefits that are “notional pension property” depends on whether they are accrued in money purchase (also called defined contribution or “DC”) “arrangements” or DB “arrangements”. Arrangements are a taxation concept. HMRC applies the taxation rules relating to pension lump sums and death benefits by reference to a member’s arrangements within a scheme. A member can have several arrangements in the same scheme. DB benefits and money purchase benefits cannot be provided from the same arrangement, therefore typically within a DB scheme a member who has paid additional voluntary contributions will have a DB arrangement consisting of the main scheme DB benefits and a separate DC arrangement consisting of their additional contributions provided on a DC basis.
The benefits that will be subject to IHT will be determined as follows:
Calculate the notional pension property in respect of DB arrangements and deduct the amount of any benefit within that notional pension property that may only be paid as an excluded benefit.
Calculate the notional pension property in respect of DC arrangements and deduct the value of any of that notional pension property that may only be used to provide an excluded benefit.
The value of the pensions for IHT purposes will be 1 plus 2 above.
Details of what constitutes notional pension property for DB arrangements and DC arrangements and excluded benefits are set out below.
DB arrangements notional pension property
The notional pension property of DB arrangements is determined by adding together:
the amount of any benefit that must be paid as a lump sum death benefit under the arrangement on the death of the member;
the amount of any benefit not within 1 that may be and can reasonably be expected to be paid as a lump sum death benefit under the arrangement on the death of the member; and
the amount of any benefit that may be and, assuming that the maximum amount possible is paid as a lump sum death benefit, can reasonably be expected to be paid as a “scheme continuation payment” under the arrangement on the death of the member.
These provisions will cover such lump sums as defined benefit lump sum death benefits, pension protection lump sum benefits and trivial commutation lump sum death benefits. They also cover scheme continuation payments. These are guarantees of the payment of a member’s pension for up to 10 years from its commencement which must be paid as pension (other than when paid as trivial commutation lump sum death benefits).
Notional pension property will therefore include the various types of pension guarantee provisions available under which pensions are guaranteed for a period (which is commonly five years) and amounts paid as trivial commutations on death.
applies where a lump sum must be provided. Trustees may be able to decide whether a guarantee is paid as a lump sum or a pension.
will apply where the trustees have the option to pay a lump sum or pension, but it can be reasonably expected that a lump sum will be paid.
will apply when the pension guarantee can only be paid as pension or when the trustees have the option to pay it as a pension or a lump sum and it can reasonably be expected that it will be paid as a pension.
Where the trustees have an option, it may be anticipated that there will, in all or most cases, be an existing reasonable expectation as to the form in which the benefits will be paid and therefore that they should come within either 2 or 3. This may be based on past practice. It is unclear how this would be resolved in any case where no reasonable expectation can be determined either way, or whether benefits could fall outside of notional pensions property on the basis that there is no requirement that that they “must” be paid as a lump sum or as a pension, and no reasonable expectation of the form in which it will be paid.
Alternatively, it may be that, once the discretion has been exercised, it is considered that the benefit “must” then be paid either as lump sum or a pension in accordance with that exercise and therefore will fall within the appropriate notional pension property definition. The position may be clarified in HMRC practice notes. If a pension is actually paid to a dependant, it should be a “dependants’ scheme pension” and would be an excluded benefit in any event.
For IHT purposes the amount of a pension continuation payment is determined assuming that the maximum amount possible is paid as a lump sum death benefit. It is therefore assumed that none of the permitted circumstances allowing for the termination of the guarantee period will occur and, presumably, that the maximum pension increases will apply, although it is unclear how this will be calculated if they are in line with uncapped CPI or RPI.
DC arrangements notional pension property
For DC arrangements the amount of the notional pension property is the sum of:
the value of any property that:
is held in a pension pot; and
may or must be used to provide benefits under the arrangement on the death of the member; and
the value of any property that:
is not held in a pension pot; and
may be and can reasonably be expected to be used to provide benefits under the arrangement on the death of the member.
The reference to “held in a pension pot” means the property is available to provide benefits to or in respect of a specific member.
Excluded benefits
The “excluded benefits” that are deducted from the sum of the DB notional pension property and the DC notional pension property are benefits that may only be paid under the scheme as one or more of the following:
a dependants' scheme pension – these are pensions payable on death to a members’ dependants, which include surviving spouse’s and civil partners the usual categories of children and financial dependants for Finance Act 2004 purposes.
a trivial commutation lump sum death benefit (TCLSDB) whose payment to a person extinguishes the person's entitlement to a dependants' scheme pension – trivial commutation of a dependant’s scheme pension on the death of a member for a TCLSDB may be discretionary at the option of the scheme trustees. These benefits would still fulfil the requirements that they “may only be paid under the scheme” for one or more of the specified benefits because both the options, a dependant’s scheme pension and a TCLSDB are specified in the excluded benefits list.
a dependants' annuity, or a nominees' annuity, that was purchased together with a lifetime annuity payable to the member. It seems unlikely that this type of excluded benefit will be applicable to DB Schemes.
benefits (in any form) payable in respect of a member of the scheme payable only if the member is in employment or other work of a particular description immediately before their death.
This covers death in service payments. The Act removed a requirement for the member to be an “active” member and any doubts as to when that would mean for this purpose. The member does not therefore need to be accruing or (in the case of a deferred member) continuing to accrue any other benefit (such and in a life assurance only scheme) and any issues as to what is meant by accruing benefits as for this purpose are avoided.
Spouse and civil partner exemption and charitable exemption
Notional pension property passing to a spouse or civil partner and to charities will be exempt from IHT.
Discretionary trusts
Currently lump sums will be subject to IHT if they are paid to a member’s estate or are considered for taxation purposes to be part of their estate. Consequently, on the death of a member, lump sums are usually payable under a discretionary trust where the Trustees may pay the monies to any one or more persons from a broad category of dependants, relatives and other persons. Members may nominate their preferred recipient or recipients, but any nominations made in “expression of wish” forms are not binding on the Trustees. Benefits payable on these terms do not currently fall within a member’s estate for IHT purposes.
After the IHT changes come into effect the lump sums will (except on the death of an active member) always be subject to IHT, therefore the original purpose of the discretionary trust will have been lost and the necessity for or desirability of the discretionary trust may be questioned. Trustees may not wish to change their practices because of the IHT changes. There may be issues around altering scheme’s rules in relation to the existence or scope of a discretionary trust, or trustees fettering their discretion under the discretionary trust if it is the agreed to abide by expression of wish forms.
In addition, discretionary trusts may still have some advantages, as they allow trustees to assess the circumstances arising on a member’s death. Alterations to IHT may change some of the trustees’ considerations on deciding how to exercise their discretion, for example it may be thought more appropriate to pay monies to a member’s estate (where that is an option) which will distribute assets in accordance with the member’s will, or to make a payment to a spouse or civil partner where IHT thresholds are exceeded and such a payment as an exempt transfer may reduce the IHT payable.
Trustees can amend schemes by resolution to extend the class of persons who can receive benefits on the death of a member, and they may wish to consider whether it would be appropriate to do so. Discretionary trusts on a wind up may however become less necessary if availability is an issue. The desirability of a discretionary trust can be assessed on establishing a new scheme.
Payment of IHT
The deceased member’s personal representatives (PRs) are primarily liable for the IHT. They can serve a withholding notice on pension scheme trustees to restrict the amount of the deceased’s death benefit that may be paid to 50% and can also require the trustees to pay the IHT relating to the notional pension property.
A “withholding notice” may be served when the PRs know or have reason to believe that they may be liable for tax attributable to notional pension property in relation to a scheme. When a withholding notice is in effect the trustees may not pay more than 50% of the benefit entitlement of a person payable on the member’s death. The person’s benefit entitlement for this purpose is the value of the notional pensionable property payable to them on a just and reasonable apportionment (having regard to appropriate actuarial assumptions) other than excluded benefits and benefits payable to spouses, civil partners and charities.
The notice must comply with requirements that will be specified by regulations. A notice will remain in force until the earlier of its withdrawal by the PRs, the payment of all tax and interest in respect of affected benefit entitlement, and 15 months from the end of the month in which the member died. Any withheld payments falling due in this period will be suspended until the end of the period.
The person responsible for the tax can require the trustees to pay the IHT payable on the notional pension property. The trustees must pay the tax within 35 days of receipt of notice if the notice is not withdrawn and fulfils certain requirements. The notice must specify the amount payable, which must not be less than £1,000 or more than the notional pension property of the member under the scheme. The amount must also not be more than the amount of the relevant benefits payable on the member’s death less any such benefits already paid and any amounts specified in earlier notices.
Where the trustees make a tax payment, a consequential adjustment may be made to the relevant benefits payable. The adjustments must be made on a basis that is fair and reasonable having regard to appropriate actuarial assumptions and any tax previously paid. Any repayment of overpaid tax can (and can only) be made to the PRs or the appropriate beneficiary.
The scheme’s rules will be void to the extent necessary to allow the payment of tax under these requirements and any adjustments of benefits in relation to such payments.
If you would like to discuss how these changes may affect your scheme, or need support reviewing your benefit arrangements, please get in touch with our Pensions team.
