Change Mindset Inheritance Tax on Pension Scheme Trustee Pay Outs on Death
Published / Last Updated on 01/08/2025
We have already covered the fact that in the Autumn Budget 2024, Chancellor Rachel Reeves announced that unused pension funds will be included in the estate calculation for inheritance tax (IHT) purposes from April 2027 and we have suggested that people need to change the mindset on pensions.
See IHT on Pensions - Reset Your Strategy
Pension Schemes are Trusts
Many people may not be aware that most pension schemes (except for some older schemes) are discretionary trusts. This is why you may have seen a yearly pension scheme trustees report.
- Your pension fund is held in trust for you under a discretionary trust.
- This means it is at the discretion of the trustees who they pay out benefits to. This is you in life but in death, the pension fund is paid out at the trustees’ discretion i.e., the trustees decide in who’s best interest the funds should be paid out to.
- You will have completed an ‘expression of wishes’ as to whom you would like pension funds paid to on death. Usually your legally married spouse, civil or children.
- The trustees will usually try to comply with this, but it is still at their discretion and if they feel it is in the best interests to have the pension paid out to e.g., if you have a financial dependent e.g., your ‘unmarried’ spouse or dependent children, they may overrise what your expression of wishes says and pay to other financial dependents.
This is where a problem may arise and create a dilemma for the pension scheme trustees as any pay out may or may not be subject to inheritance taxes from 2027. See the following examples:
Example 1: Expression of Wishes Leaves Pension Fund to Legal Spouse/Civil Partner
- This would be IHT free as gifts between spouses on death are IHT free. IHT may only then be relevant on 2nd death.
- If there are other financial dependants (at the time of death) e.g. , children, the trustees may use their discretion to pay some or all pension benefits to other dependants.
- From April 2027, this may be subject to inheritance taxes if total wealth (including pension funds) is over inheritance tax nil rate bands (£320,000 Ni. Rate Band and £175,000 Residential Nil Rate Band).
- What if the children are financially independent but are in much greater need of funds rather than the surviving spouse/civil partner?
- From April 2027, this may be subject to inheritance taxes if total wealth (including pension funds) is over inheritance tax nil rate bands (£320,000 Ni. Rate Band and £175,000 Residential Nil Rate Band).
Example 2: Expression of Wishes Leaves Pension Fund to Unmarried ‘Common Law’ Life Partner
- From April 2027, this may be subject to inheritance taxes if total wealth (including pension funds) is over inheritance tax nil rate bands (£320,000 Ni. Rate Band and £175,000 Residential Nil Rate Band).
Example 3: Expression of Wishes Leaves Pension Fund to Non-Financially Dependent Children or Other Loved Ones and not the Legal Spouse/Civil Partner
- From April 2027, this may be subject to inheritance taxes if total wealth (including pension funds) is over inheritance tax nil rate bands (£320,000 Ni. Rate Band and £175,000 Residential Nil Rate Band).
- The pension scheme trustees have the power to override this, e.g., if there is a surviving, legally married spouse that is not reliant on this pension fund, What do the trustees do?
- Pay our as per the expression of wishes, knowing that IHT may be payable.
- Overrule the expression of wishes and pay out to the legally married spouse/civil partner meaning there is no IHT to pay.
- This is the dilemma for pension scheme trustees.
- Do the children take legal action because they have been denied access the funds?
- Does the legal spouse/civil partner take legal action because by paying out to children, the payment may have created an IHT bill when it could be paid to the spouse/civil partner with no IHT to pay?
This is a mess, and we suggest it will either be ‘test’ legal action to establish legal precedent or guidance notes need issuing for best practice by HMRC, the government and pension regulators.
Talk to us about our ‘In Retirement, Inheritance Tax, Later Life and Care Planning Strategy Review’.
See: Later Life & Inheritance Tax Review
Other useful links:
