Inheritance tax on unused pension funds

The UK government announced in the October 2024 Budget that they would be bringing certain unused pension funds into the scope of IHT on the death of the Member of the scheme, with effect from 6 April 2027.

The legislation governing this change was first published in July 2025 and has undergone various amendments as it passed through Parliament. On 18 March 2026, the Bill received Royal Assent and was enacted as Finance Act 2026.

The charge to IHT on pension funds is largely intended to deter individuals from retaining funds within their pension schemes. Currently, most pension funds are exempt from IHT on the Member’s death and therefore they have been used by some as IHT deferment vehicles to pass wealth to the next generation. The new legislation is also supposedly intended to ensure consistency of IHT treatment across most types of pension scheme, although certain unapproved pension schemes will remain outside the scope of the new rules.

After 5 April 2027, pension funds could be subject to 40% IHT on the death of the Member and the remaining funds would incur up to 45% income tax in the hands of any UK resident death beneficiaries or 20% in the hands of a Guernsey resident death beneficiary (subject to any tax-cap provisions applying). The effect of the new rules could therefore be extremely punitive.

The key considerations in relation to the new rules are as follows:

Who will the new rules apply to?

The rules will apply to Members of UK registered pension schemes, Qualifying Non-UK Pension Schemes (QNUPS) and s.615(3) schemes.

A QNUPS is a scheme that meets the requirements of the QNUPS regulations, which were introduced with effect from April 2006, primarily to ensure that Qualifying Recognised Overseas Pension Schemes (QROPS), which largely mirror UK registered pension schemes, could benefit from IHT exemption in the same way as UK pension schemes. However, in practice, QNUPS have become a” product” in their own right and following the introduction in April 2017 of more punitive IHT legislation in respect of UK residential property, they have become more widely used as IHT planning vehicles.

A s.615(3) scheme is broadly an occupational scheme set up by an overseas business for its employees who work outside the UK.

However, some unapproved pension schemes will remain outside the scope of the new rules. Pre-6 April 2006 FURBS (which are non-registered occupational pension schemes) can currently benefit from a “grandfathered” exemption from IHT on the Member’s death and this has not been removed. However, such schemes could potentially still be exposed to IHT on the Member’s death if the Member is treated as having omitted to exercise his right to take pension benefits during his lifetime. Therefore, careful consideration of the position is still needed for such schemes.

On what basis will IHT be charged?

The new IHT rules will operate by treating the Member of the pension scheme as being beneficially entitled to “notional pension property” immediately prior to death. In most cases, this will be the value of the Member’s pension “pot” that can be used to provide death benefits, reduced by the value of any “excluded benefits”.

Excluded benefits include death in service benefits (i.e. where the deceased was an active member of the pension scheme), dependents scheme pension (i.e. a pension paid after the death of the Member to any of his dependents, typically a spouse, a child aged under 23 or another financial dependent) or a trivial commutation lump sum death benefit (up to £30,000).

The value of the notional pension property will be comprised in the Member’s estate on death. Whether this property is relevant property (which will be subject to IHT at 40%) or excluded property (which will not be subject to IHT) will depend on the status of the Member as a long-term resident (“LTR”) of the UK and on whether the pension scheme is “established” in the UK or offshore. This generally means where the main administration of the scheme is carried out (and could therefore change over the lifetime of the scheme).

The new legislation specifically states that notional pension property will be treated as situated in the country or territory in which the pension scheme is “established”. Therefore, notional pension property comprised in a UK registered pension scheme will be treated as a UK situs asset for IHT purposes, whereas notional pension property comprised in a QNUPS or s.615(3) scheme will be a foreign situs asset.

If the Member is not a Long-Term Resident (LTR) at the time of his death (and hence only subject to IHT on UK situs notional pension property), any value held in a QNUPS or a s.615(3) scheme should be excluded property and hence will be outside the scope of IHT charges on the Member’s death.

If the Member has remained UK resident (and is hence an LTR), his worldwide assets (so including any notional pension property, whether held in a UK registered pension scheme, a QNUPS or a s.615(3) scheme, will be subject to IHT on death.

In view of this, there may be a greater incentive for Members who are leaving (or have left) the UK to transfer their UK registered pensions funds to a QROPS (which should also be a QNUPS), in order to ensure that the value is excluded property (and thus outside the scope of IHT) on their death, although the Overseas Transfer Charge provisions would need to be considered.

Exemptions from charge

The IHT spousal exemption provisions will apply in respect of notional pension property that passes from the pension scheme to the Member’s spouse or civil partner in the form of death benefits (regardless of whether the Member’s spouse has an immediate or future right to receive the death benefits).

Exemptions from IHT will also remain available for death benefit payments made to charities or registered clubs, qualifying political parties, housing associations or for national purposes or the maintenance of historic buildings.

Notional pension property that forms part of the Member’s estate on death could, on the face it, qualify for relief under the new BPR and APR rules that have been in force since 6 April 2026 (i.e. a 100% relief allowance of £2.5 million per spouse, with 50% relief applying thereafter).However, in practice, as the Member is only treated a beneficially entitled to the pension assets immediately before death, it seems that the requisite two-year holding period for such assets cannot be met and therefore no BPR or APR would be available.

Who pays the IHT liability?

The persons liable for the IHT due on the notional pension property on the Member’s death include the Member’s personal representatives (PRs) and any person in whom the property is vested. For UK registered pension schemes only, the scheme administrator can, in certain limited circumstances, also become liable. The trustees of registered pension schemes and s.615(3) schemes are specifically excluded from being liable, but this exclusion does not extend to the trustees of a QNUPS.

For a UK registered pension scheme, a death beneficiary in whom property has vested can notify the scheme administrator to pay the IHT attributable to the assets received on their behalf (and such a payment will be treated as an authorised member payment, so will not give rise to an unauthorised payment charge).

When do the rules take effect?

The new rules will take effect for transfers of value (i.e. on the death of the Member of the pension scheme) that occur on or after 6 April 2027.

The new IHT legislation for pension schemes does not impact the current position relating to trust-based IHT charges (10-year charges and exit charges). Therefore, the exemption from these charges that is currently available to UK registered pension schemes, QNUPS and s.615(3) schemes, remains in place.

Planning considerations

Individuals with pension schemes (whether in the UK or offshore) should seek professional advice regarding the implications of the new IHT rules to enable them to consider their position and the options available.

The LTR status of pension schemes members (especially those who are older or in poor health) should be established to ascertain their potential IHT exposure on death.

For UK schemes with Members who are not (or who will shortly cease to be) LTRs, a transfer to an offshore scheme (a QROPS) could be considered.

Long term Guernsey resident members of Guernsey RATS (which are likely to be QNUPS) should be outside the scope of IHT on death as non-LTRs.

Members who have reached retirement age and are likely to come within scope of the new IHT regime (i.e. Members of UK registered pension schemes or Members that will remain LTRs) could consider the option of extracting funds from their pension schemes before 6 April 2027 and using estate planning strategies (e.g. making lifetime gifts to family members, which should have no IHT implications providing the Member survives 7 years, or reduced IHT exposure if the Member survives more than 3 years but less than 7 years) to reduce their IHT exposure on death.

Members who have relocated to Guernsey (or are looking to do so) would have the option of withdrawing their pension funds with no UK tax exposure under the UK/Guernsey double tax agreement. Guernsey income tax of 20% would be payable but this could potentially be limited under one of Guernsey’s tax caps, depending on personal circumstances and the values involved. The extracted funds would remain exposed to IHT (in the event of the Member’s death) for up to 10 years, but term assurance may be a viable option for managing this risk.

If you would like to discuss the changes, please contact Mandy Connolly, our Head of Tax Technical: mandy.connolly@lts-tax.com