The Government's plan to make pensions liable for inheritance tax has upset a lot of families' plans to protect estates from the taxman.

Its intention to levy inheritance tax on death benefits too has received far less attention, but could be even more significant to some grieving relatives.

Experts in the pensions industry say that compounding the issue it is not clear whether all death benefits will be caught in the inheritance tax net, including some death-in-service payouts to grieving families if someone dies while employed.

This could also lead to long waits for payouts, while inheritance tax matters are sorted out, rather than the current situation where families can often get much-needed cash almost immediately. 

The Firefighters Pension Advisory Scheme (England) has written to HMRC warning that the families of its members who die in the line of duty could lose out.

Death benefits will still be exempt from inheritance tax if left to spouses, or if they are dependants' pensions left to children under 23 or older children still reliant on the deceased for health reasons.

But if you nominated other adult children or anyone else to receive death benefits, or if you get divorced, money experts are advising people to review this in light of the changes pending in spring 2027. Here's what you need to know.

What are death benefits?

Death benefits cover a wide range of payments, both income and lump sums, paid out by work pension schemes when someone who is a member sadly dies.

There is a useful rundown of all the types of death benefits that might be paid out by defined contribution (invested pots) and defined benefit (guaranteed income) pension schemes on the MoneyHelper website here.

'Death benefits are the financial provisions made by pension schemes to beneficiaries when the scheme member passes away,' says Jon Greer, head of retirement policy at Quilter.

'These benefits can vary depending on the type of pension scheme and whether the member was still actively contributing or had left the employment tied to the scheme.

'Common forms of death benefits include lump-sum payments, ongoing beneficiary pensions, and other scheme-specific arrangements.'

Greer says it is important to check the specific death benefits your pension scheme would offer to your family and how these might be applied under various circumstances.

How do death benefits work now? 

Under most pension schemes, and this goes for both defined contribution and defined benefit ones, they make the final decision on who receives any death benefits that are owed.

You can nominate whoever you want to receive death benefits via an 'expression of wishes' form.

However, if you have a defined contribution pension it's down to the discretion of the provider or trustees who gets the money.

If you have a defined benefit pension, death benefits will be paid out according to its rules, although again trustees retain discretion.

A reason that pension schemes do this is because family relationships and who is a dependant can get complicated.

There can be competing claims - especially if you haven't updated your expression of wishes to name a new partner - so most pension schemes make the ultimate decision. They sometimes even split benefits like a lump sum several ways in order to be fair.

Another reason pension schemes take this approach is that at present discretionary death benefits escape the inheritance tax net.

Sean McCann, chartered financial planner at NFU Mutual, explains: 'Currently where the pension scheme rules (DB and DC) give discretion over where death benefits are paid, they are free of inheritance tax.

'The member can nominate who they would like to benefit but the final decision rests with the scheme. The overwhelming majority of pensions have this discretion written into their rules.'

However, McCann adds that some pension schemes, including the very large NHS one, have non-discretionary rules which means they must follow the member’s directions on who gets death benefits.

And he says in such cases, non-discretionary death benefits are already treated as part of the deceased’s estate for inheritance tax purposes.

How will IHT be applied to death benefits from 2027 

Starting in April 2027, both unused pensions and death benefits are going to become liable for inheritance tax like other assets such as property, savings and investments.

There will no longer be a difference in the way discretionary and non-discretionary death benefits are treated when inheritance tax is calculated.

Spouses and civil partners are exempt from inheritance tax anyway, so this won't affect death benefits paid to them.

But McCann warns: 'While pension death benefits paid out to spouses and civil partners will be free of inheritance tax, those paid out to children will in many cases be included in the inheritance tax calculation.'

He says regarding children that an inheritance tax exemption will apply to death benefits where they are paid as a ‘dependants scheme pension’ - usually from a defined benefit scheme

That means children receiving death benefits will be exempt if they are aged under 23 when the member dies, or over 23 but dependant on the member because of physical or mental impairment, explains McCann.

However, benefits paid to a dependant in any other form, such as a dependant’s annuity or drawdown, will be liable for inheritance tax.

Greer says the types of death benefits available from pension schemes - such as lump sums or beneficiary pensions - are expected to remain unchanged from spring 2027.

However, the process is likely to become more intricate for the executors or administrators – known as 'personal representatives' – responsible for sorting out an estate.

'They will need to gather detailed information from multiple pension schemes and carry out more extensive calculations to ensure the fair apportionment of inheritance tax on death benefits,' he explains.

'There may be scenarios where personal representatives are required to report on inheritance tax payments that would not have previously applied or, in some cases, higher amounts of inheritance tax than would have been due under current rules.

'This means that a large number of estates are likely to incur inheritance tax, particularly where unused pension funds are included.'

How many people will be affected by IHT changes, and what extra tax will be raised?

Pension consultant LCP explains that for many beneficiaries there may be no inheritance tax due, but the new process proposed by the Government will still affect them.

It expects the changes to delay payment of death benefits while pension schemes liaise with the deceased’s personal representative to work out what they need to hold back for inheritance tax purposes.

'This is a huge change for death benefits which will go far beyond disrupting those with estates above the inheritance tax threshold who were planning on passing on some of their pension wealth to others free of inheritance tax,' it says.

'For example, it could impact unmarried couples where one moderately earning partner dies in their 20s or 30s and a lump sum death benefit of say four times their salary is paid. It could also operate on the death of a single parent.'

Will life assurance death benefits be liable for IHT?

LCP says the Government's proposals may have an impact on some life assurance death benefits, but the HMRC consultation document is not definitive on this point.

It currently looks as if group policies set up as 'excepted' life arrangements under trust which are not registered with HMRC will remain outside the scope of inheritance tax.

However, group life assurance policies set up under trust and registered with HMRC will fall under inheritance tax.

This might be clarified, and the latter exempted too. For now, LCP is advising employers and pension schemes to check which type of group life assurance policy arrangement they currently have and review this if necessary.

See more below on this issue.

What action should you take ahead of new rules in 2027?

Keep pension death benefit nominations updated, especially if you get married or divorced.

‘This major change is a reminder to check who receives your pension savings should you die, and this applies to personal pensions and Sipps as well as occupational schemes,' says Emma Sterland, chief financial planning director at Evelyn Partners.

'In workplace schemes this can often be a separate form to the nomination for death in service benefits.'

She warns: 'Some people might currently have nominated one or more children as well as or instead of their spouse or civil partner.

'They might want to keep it this way, but should be aware that from April 2027 leaving this asset to a spouse or civil partner will probably be more tax-efficient.'

Regarding the life assurance death benefits discussed above, Sterland says many employers offer these as part of a workplace pension, in the form of a tax-free lump sum - often three to four times salary - paid to a person of your choice if you die while working for the company.

'At the moment such payments paid out by occupational pension schemes are not counted as part of an estate for inheritance purposes, but under the new rules they probably would be,' she says. 'Although the inheritance tax issue might only occur if you have nominated someone other than your spouse or civil partner, because of the spousal inheritance tax exemption.'

She says anyone concerned about the inheritance tax implication of such a payout should check with their employer what type of death-in-service scheme they have in place.

'Newer types of "excepted" death in service benefits could mean that inheritance tax is avoided on the payout in all cases and for most employers it is relatively straightforward to switch to such a scheme.'