The Finance (No. 2) Bill was published on 4 December 2025, setting out how the Government intends to bring most unused pension funds and death benefits within scope of inheritance tax (IHT) as of 6 April 2027.
Finance (No. 2) Bill and IHT
The Finance (No. 2) Bill and explanatory notes set out how the Government intends to bring most unused pension funds and death benefits payable from a registered pension scheme within the scope of IHT from 6 April 2027. Certain features of this new regime have changed since the draft legislation from July 2025, albeit the overall premise remains the same.
Bringing inherited pensions into the IHT regime will mean that if the value of pension savings takes the value of the deceased’s estate over the IHT threshold (currently £325,000, or £500,000 if it includes the family home which is passing to direct descendants - and remaining at this level until 2030), tax will be levied (subject to other exemptions that might apply, such as the exemption on inheritance by a spouse/ civil partner). The current IHT rate is 40%.
In response to concerns raised during the consultation process about the position of the deceased’s personal representatives (PRs) who will be responsible for reporting and paying any IHT due, the Government has introduced two easements:
- If they know or have reason to believe that IHT may be due, PRs will be able to require pension scheme administrators (PSAs) to withhold 50% of pension death benefits which may be subject to IHT for up to 15 months after death and pay the IHT due (a Withholding Notice). This is to make sure that enough funds are available to cover IHT.
- PRs will also receive a discharge from liability for pensions identified after they have received clearance for settling IHT due on the estate unless they have been careless as to disclosure of the ‘notional pension property’ that is subject to IHT.
Which death benefits will be excluded from IHT? Notional pension property included, but ‘excluded benefits’ not
The legislation introduces a ‘notional pension property’ model – such property is attributable to IHT but their ‘excluded’ benefits are not.
Notional pension property is the value of any money purchase benefits held that might or must be used to provide death benefits plus any defined benefit lump sum death benefits and ‘scheme continuation payments’ (member pension payments that continue for a guaranteed period after death).
Excluded benefits include: a dependant’s scheme pension; a trivial commutation lump sum death benefit; a dependant’s or nominee’s annuity purchased with a member’s lifetime annuity; and active member benefits.
The active member exclusion covers any amount that: (i) is payable as a benefit in respect of a member who was accruing benefits and who was in employment/ work immediately before death; and (ii) is not payable as a benefit in respect of a member if the member does not meet these conditions. The precise scope of the active member wording will need some careful thought.
The current exemptions from IHT for property passing to a spouse or civil partner, charity or registered club, will also continue to apply to the member’s notional pension property.
(This means that unused defined contribution (DC) savings, dependants’ drawdown pensions and lump sums payable following death in deferment or in retirement will be in scope).
Who is liable to pay IHT on in-scope death benefits?
As the Bill’s explanatory notes explains, pension beneficiaries and PRs will be liable to pay IHT. However, this is subject to the PSA paying where there is a Withholding Notice or it is notified to do so by the PR/ pension beneficiary under a direct payment scheme (a Direct Payment Notice).
A Withholding Notice takes effect until it is withdrawn, the IHT and any interest due is paid, or 15 months after the member’s death.
The PR/ pension beneficiary can issue a Direct Payment Notice requiring the PSA to pay any IHT due within 35 days of receiving such a notice where the IHT due is £1,000 or more.
The PSA will become liable to pay the IHT if it pays a benefit in breach of a Withholding Notice or does not comply with a Direct Payment Notice.
The PSA has the power to pay the IHT due even if the scheme rules do not allow for this and can reduce the benefits by the IHT amount.
How will the PR-led IHT reporting and payment process work?
The existing 6-months from date of death deadline for PRs paying IHT will remain – this means that schemes have less time to process death benefits than they are used to (currently two years from notification of death) and will need to work quickly to determine beneficiaries and process the death benefits due.
The consultation response included a high-level outline of the reporting and payment process.
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Stage 1: PRs will notify the PSAs about a member’s death and whether there is a surviving spouse or civil partner. PSA will provide the value of unused pension funds/ death benefits to the PR within four weeks of this notification. The PSA will also inform the PR of the split of pension benefits between exempt and non-exempt beneficiaries.
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Stage 2: PRs obtain information from every PSA and other parts of the deceased’s estate, value the total estate and work out whether IHT is payable.
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Stage 3: If IHT is payable, PRs will work out how much is attributable to the different pension elements of the estate, provide an account to HMRC and tell the beneficiaries of the IHT amount due on their element.
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Stage 4: Intersecting with stages 1-3, the PSA and trustees will identify beneficiaries and distribute the pension benefits. They will need to tell non-exempt beneficiaries that IHT may be payable, they have joint and several liability, and the options for payment.
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Stage 5: The PRs will deal with adjustments to the estate and send amended IHT accounts to HMRC.
Income tax changes
The Bill also amends income tax legislation to prevent a pension beneficiary from paying double tax. Where IHT has been paid with the burden passing to the beneficiary, a deduction on the amount of taxable pension income will be made equal to the IHT. Without such changes, a beneficiary could receive pension income that has already been subject to IHT and then get taxed again on the full amount under income tax provisions.
The changes will also allow income tax to be adjusted to account for any decrease in IHT liability resulting from direct payment of IHT from the death benefits. Allowing for an adjustment will prevent underpayment of income tax.
There will be a procedure for recovering overpaid tax.
Next steps
The IHT changes will have an impact on schemes and how they process death benefits. They will have to:
- Work out which benefits are in scope of IHT.
- Consider scheme and member communication and how standard communications may need amending to reflect the new regime.
- Work with the PSA to adjust administration processes to comply with the new requirements. Consideration will need to be given to notification procedures, information gathering, the exercise of any discretions, implementing procedures to comply with a Withholding Notice or Direct Payment Notice, and how information will be shared between the scheme and the PRs/ pension beneficiaries. Further materials on the PR-led reporting and payment process are expected.
Finance (No. 2) Bill and collective defined contribution (CDC) schemes
As announced in the Autumn Budget, the Bill also includes the provisions which will:
- allow unconnected, multiple employer CDC schemes to apply to HMRC to become a registered pension scheme under the Finance Act 2004 through treatment as an occupational pension scheme for 2004 Act purposes – (change takes effect from date of Royal Assent but no practical application until 31 July 2026 when UMES regulations (Unconnected Multiple Employer Schemes) come into force);
- allow HMRC to refuse to register or de-register an unauthorised CDC scheme; and
- give HMRC the power to legislate for CDC schemes through regulations for efficiency purposes.
Finance (No. 2) Bill and tax advisers
The Bill is also introducing requirements for tax advisers to register with HMRC as of May 2026 if they are going to interact with HMRC on behalf of a client unless an exception applies. There has been concern in the pensions industry that this requirement could catch scheme administrators and trustees who interact with HMRC, for example, if they deal with tax reporting.
However, HMRC’s Newsletter 176 explains that the exception covering interaction with HMRC required to comply with an obligation under any enactment “responds to feedback from the pensions industry that earlier draft legislation could bring pension scheme administrators and practitioners into scope through entities responding to a range of mandatory reporting requirements” and that this exception covers entities such as administrators. As such, this should allay concerns that administrators/ trustees may be caught. Furthermore, HMRC has explained that providing information to members, such as about the annual allowance charge, is not caught by the registration requirement, as there is no interaction with HMRC.