Inheritance tax and pensions, explained

Generally speaking, when a pension scheme member dies, their pension can be passed on to beneficiaries without inheritance tax being due.

As part of our Bitesize Technical series, Senior Technical Consultant Lisa Webster looks at the exceptions to this rule, where the pension may fall within the deceased member’s estate.

Please note: These are the current rules for pension death benefits. Changes to the tax treatment are due to come into force from 6 April 2027.

Key insights on inheritance tax and pensions

Binding nominations

If the scheme trustees allow the member to make a binding nomination, so that they cannot exercise discretion and are bound to pay the death benefits to named individuals, the full value of the pension fund will fall into the deceased member’s estate. If the pension is paid to the spouse, then the spousal exemption can be used.

Contributions made when in ill-health

If the member makes substantial contributions in the two years prior to their death, and these contributions were made in the knowledge of ill-health and were not a continuation of regular contributions made for a longer period, these sums could be classed as transfers of value. This would mean that they are deemed to be lifetime transfers, and subject to inheritance tax.

Transfers made in ill-health

Another example of a lifetime transfer could be a transfer between pension schemes when the member is in ill health. HMRC takes the view that, at the point of the transfer, the member could redirect the death benefits under the new pension to the estate, for example using an expression of wishes included as part of the new pension application process.

How much inheritance tax could be payable?

Inheritance tax could be payable on what HMRC values as the loss to the estate, which is calculated on a case-by-case basis by HMRC actuaries. This is roughly the difference between the amount that could be directed to the estate as death benefits, and what the member could have accessed at the point of transfer from the new pension. It is not the whole transfer value.

HMRC has indicated that if drawdown income continued at least at the same level after a transfer as was payable before, then it is unlikely to make a claim.

As both contributions and transfers in ill-health are lifetime transfers, no spousal exemption applies, even when the spouse is the recipient of the death benefits.

Could all pension transfers in ill-health be caught?

In practice, it’s only transfers in ill health from defined benefit to defined contribution pensions that are likely to be caught, and even in these instances inheritance tax will not definitely apply.

Theoretically, there’s no time limit on how far back HMRC can look for lifetime transfers. However, as only transactions in the two years prior to death have to be reported on the IHT409 form, it’s very unlikely that older transactions will be looked at.

More Bitesize Technical

Get stuck into ‘Lump sum death benefits, explained’ – the next instalment of our pension death benefits Bitesize Technical series.