We previously looked at three practical steps individuals may wish to consider ahead of the changes. Here, we look more closely at pension death benefit nominations, how decisions about pension benefits are made after death and whether there is any scope to change their distribution once a member has died.
Pension Death Benefits
Unlike estate assets such as your home, savings and investments, which typically pass under the terms of your Will, pension death benefits are generally distributed under the rules of the pension scheme.
Pensions are often held within discretionary arrangements under which the scheme trustees decide who should receive death benefits. Whilst trustees will usually take account of an expression of wish or letter of wishes completed during an individual's lifetime, they are not bound by this direction.
As a result, pension death benefits do not normally form part of the deceased's estate and, under the current rules, are usually outside the scope of inheritance tax.
This distinction is important because, whilst pension benefits have historically sat outside the inheritance tax regime, the proposed changes from April 2027 will alter their inheritance tax treatment without changing how the benefits are distributed.
What Is Changing?
From April 2027, unused pension funds and certain pension death benefits are expected to be treated as notional assets for inheritance tax purposes. A notional asset is treated as forming part of an estate for inheritance tax purposes, even though it does not pass under the terms of a Will.
This creates an unusual position whereby pension death benefits may be taken into account when calculating an inheritance tax liability on death, whilst continuing to be distributed by the scheme trustees under the pension scheme rules rather than by the executor.
Executors are expected to become responsible for reporting the value of pension benefits to HMRC and accounting for any associated inheritance tax, despite having no control over their distribution.
This separation between taxation and distribution raises an important practical question. Where assets pass under a Will, beneficiaries may often be able to rearrange matters after death through a Deed of Variation. If pensions are brought within the inheritance tax regime, will a similar option be available in relation to pension death benefits?
What Is a Deed of Variation?
A Deed of Variation allows a beneficiary to redirect an inheritance received under a Will to another person within two years of death.
However, this only applies to assets passing under a Will. Pension death benefits are distributed under the pension scheme rules rather than under a Will and, as a result, cannot be varied by a Deed of Variation.
Can Pension Trustees Reach a Different Decision?
When a pension scheme member dies, the trustees have discretion over who receives the death benefits. Although they will usually take account of the member's expression of wish or letter of wishes, they are not generally bound by it.
This raises an important question. If a different distribution of the pension benefits would produce a more favourable inheritance tax outcome, could the trustees decide to depart from the member's stated wishes?
The answer remains uncertain. Whilst family members can ask trustees to consider a different approach after death, and many schemes grant trustees wide discretion, there is currently no established mechanism equivalent to a Deed of Variation that would allow pension death benefits to be redirected after death.
The changes also mean that decisions people made about their pension beneficiaries under the existing inheritance tax rules may need to be reconsidered. For example, someone may have previously chosen for their children or grandchildren to receive their pension death benefits, when those benefits generally sat outside their estate for inheritance tax purposes.
To understand what the changes could mean in practice from a pension provider's perspective, we asked Clare Moffat, Head of Technical at Royal London, for her view. She highlights an important distinction between ensuring pension benefits reach the people the member intended to benefit and determining the most tax-efficient way of passing wealth to the next generation:
"Many people expressed a wish for their children or grandchildren to benefit from their pension death benefits. However, with the change in April, these decisions need to be reviewed and that thought process documented. Passing on other wealth through the generations may be more tax-efficient than passing on pension wealth, especially if the person who died is 75 and over and inheritance tax and income tax would apply to pensions. Pension Scheme Administrators have a responsibility to make sure that the people you would want to benefit do receive that money. But they aren't responsible for passing on wealth in the most tax-efficient way."
The practical question is therefore not simply whether trustees have discretion, but how far they may be prepared to exercise that discretion once the member has died and tax considerations have become apparent.
HMRC has published Technical Notes setting out the broad framework of the new rules. Further legislation and guidance are awaited and the position may become clearer ahead of April 2027.
Why This Matters
Taken together, these points highlight a potentially significant planning issue. Based on what is currently known, once a pension scheme member has died there may be very limited scope to alter the inheritance tax consequences of pension death benefits.
Unlike assets passing under a Will, there is no established right to vary pension benefits through a Deed of Variation. Equally, whilst pension trustees may have discretion regarding who receives benefits, there is no guarantee that they will be prepared to exercise that discretion differently from the member's recorded wishes after death.
The practical focus should therefore be on reviewing pension expressions of wish during lifetime rather than attempting to reshape matters after death.
With the inheritance tax treatment of pensions changing from April 2027, individuals may wish to review who they have nominated to receive their pension death benefits and consider those nominations alongside their Will and wider estate planning.
