Death Tax Explained: What It Means for Your Estate, Life Insurance and Pension

Written by Editor

Disclaimer: This article is for general information and educational purposes only. It does not constitute legal, financial, pension, insurance or tax advice. Inheritance Tax rules can be complex and may change. Individual circumstances, policy ownership, pension arrangements, trusts, marital status and the total value of an estate can all affect the amount of tax payable. Anyone concerned about their estate should seek advice from a suitably qualified solicitor, regulated financial adviser, pension specialist or tax professional.

Could Your Loved Ones Be Taxed on the Money You Leave Behind?

What Is a “Death Tax”?

The expression “death tax” is not the official name of a separate UK tax. It is an informal and often politically charged term commonly used to describe Inheritance Tax, sometimes abbreviated to IHT.

Inheritance Tax is a tax charged against the estate of someone who has died. A person’s estate can include:

Property and land.
Money held in bank or savings accounts.
Investments and shares.
Vehicles, jewellery and valuable possessions.
Certain gifts made before death.
Life-insurance proceeds paid into the estate.
From April 2027, most unused pension funds and pension death benefits.

Inheritance Tax is generally paid from the estate by the executor or personal representative before the remaining assets are distributed. Beneficiaries do not normally receive a personal Inheritance Tax bill simply because they have inherited something, although separate tax consequences can arise later, such as Income Tax on rental income or Capital Gains Tax if an inherited asset increases in value and is subsequently sold.

How Much Can You Leave Without Paying Inheritance Tax?

The standard Inheritance Tax threshold, known as the nil-rate band, is currently £325,000.

If the total taxable value of an estate exceeds the available threshold, the portion above that threshold is normally taxed at 40%.

For example, if an estate is worth £500,000 and only the standard £325,000 allowance applies:

The first £325,000 would fall within the tax-free threshold.
The remaining £175,000 would potentially be taxable.
At 40%, the Inheritance Tax bill would be £70,000.

An additional residence nil-rate band of up to £175,000 may be available when a qualifying home is left to direct descendants, such as children or grandchildren. This can potentially increase an individual’s total tax-free allowance to £500,000.

Unused allowances may also be transferable between married couples and civil partners. In appropriate circumstances, a surviving spouse or civil partner may therefore be able to leave as much as £1 million without Inheritance Tax becoming payable. However, the residence allowance is subject to conditions and begins to reduce for estates valued above £2 million. The current thresholds are frozen until the end of the 2030–31 tax year.

Transfers between spouses and civil partners are generally exempt from Inheritance Tax, although additional rules can apply where either person has an international residence or domicile history.

Do Your Loved Ones Pay Tax on a Life-Insurance Payout?

A common question is whether children, partners or other beneficiaries will be taxed on the life-insurance money they receive after someone dies.

The answer is: not usually as ordinary income, but the payout may still affect Inheritance Tax.

HMRC guidance distinguishes between the insurance proceeds themselves and the treatment of those proceeds as part of the deceased person’s estate. Where death ends a policy, the net proceeds are generally treated as capital rather than income of the estate.

However, who legally owns the policy and where the money is paid are extremely important.

When Life Insurance Is Paid Into the Estate

If the deceased person owned the policy and the proceeds are paid into their estate, the payout can increase the total value of the estate.

HMRC’s Inheritance Tax guidance states that when the deceased was the life assured and the proceeds form part of their free estate, those proceeds can be included when calculating the estate’s Inheritance Tax liability.

For example, suppose someone owns:

A home and savings worth £400,000.
A life-insurance policy paying £200,000 into their estate.

The estate could be treated as having a total value of £600,000 before deductions, exemptions and allowances are considered. The insurance itself may therefore push an estate above the available Inheritance Tax threshold.

This does not necessarily mean that the beneficiary personally pays tax on the insurance payment. It means that the estate may have to pay Inheritance Tax before the remaining money is distributed.

When Life Insurance Is Written in Trust

A life-insurance policy can sometimes be placed in trust for named or eligible beneficiaries.

Where the arrangement has been established correctly, the policy proceeds may be paid by the insurer to the trustees rather than into the deceased person’s estate. This can potentially:

Keep the payout outside the estate for Inheritance Tax purposes.
Allow the beneficiaries to receive money without waiting for probate.
Provide funds that can help the family meet funeral costs, household expenses or an Inheritance Tax bill.
Give greater control over when and how vulnerable beneficiaries receive the money.

However, putting a policy in trust is a legal decision. Different types of trusts have different tax and administrative consequences. Premium payments may also be treated as gifts in certain circumstances. People should not assume that every trust automatically removes all tax liability.

Existing policyholders should ask their insurer whether their policy is currently written in trust and obtain professional advice before changing ownership or beneficiaries.

The New Pension “Death Tax” Rules From April 2027

One of the most controversial changes to Inheritance Tax concerns private and workplace pensions.

Under the present arrangements, many unused pension funds are generally outside a person’s estate for Inheritance Tax purposes because pension trustees or providers retain discretion over who receives the death benefits.

From 6 April 2027, most unused pension funds and pension death benefits will be brought within the value of the deceased person’s estate when calculating Inheritance Tax.

This means that a pension pot which previously passed outside the estate may soon be added to the value of property, savings, investments and other assets.

Personal representatives will generally be responsible for reporting the relevant pension value and arranging payment of any Inheritance Tax due. Death-in-service benefits paid from registered pension schemes are expected to remain outside the new provisions.

The ordinary spouse and civil-partner exemptions should continue to be relevant where pension benefits pass to a surviving spouse or civil partner. However, pension benefits left to adult children, unmarried partners or other beneficiaries may contribute to an Inheritance Tax liability where the estate exceeds its available allowances.

Was This Pension Rule Introduced by the New Prime Minister?

The UK’s current Prime Minister, Andy Burnham, took office on 20 July 2026.

However, it is important to correct a possible misunderstanding: the plan to bring unused pensions into the scope of Inheritance Tax was not originally introduced by Andy Burnham.

The measure was first announced at the Autumn Budget on 30 October 2024 under the previous government. It was subsequently developed through consultation and legislated for in the Finance Act 2026, before Andy Burnham became Prime Minister.

The Burnham government has inherited the policy. Unless the new government amends, delays or repeals it, the reform is scheduled to take effect on 6 April 2027.

This distinction matters because public discussions can sometimes give the impression that every policy taking effect under a new Prime Minister was personally created by that Prime Minister.

Could an Inherited Pension Face Both Inheritance Tax and Income Tax?

This is one of the most disputed aspects of the reform.

Under current pension death-benefit rules, the beneficiary’s Income Tax position often depends on the pension holder’s age when they died.

Where the pension holder dies before reaching 75, many pension death benefits can currently be paid without Income Tax, provided relevant conditions are met, and the deceased person’s lump-sum and death-benefit allowance has not been exceeded.

Where the pension holder dies aged 75 or over, pension payments received by a beneficiary are generally taxable as income at the beneficiary’s applicable Income Tax rate.

From April 2027, the pension could first contribute to an Inheritance Tax charge against the estate and the remaining pension benefit could also be subject to Income Tax when received by the beneficiary.

This does not mean every inherited pension will automatically be taxed twice. The final position will depend on:

The total value of the estate.
The available Inheritance Tax allowances.
The identity of the beneficiary.
Whether a spouse or civil-partner exemption applies.
The age of the pension holder at death.
The type of pension and death benefit.
The beneficiary’s own Income Tax position.

Nevertheless, critics argue that some families could face a combined tax burden considerably higher than the standard 40% Inheritance Tax rate.

The government’s justification is that pensions should primarily provide an income during retirement rather than being used as tax-advantaged vehicles for transferring wealth between generations. It also argues that the reform will make the treatment of pensions more consistent with other inherited assets.

Why Are the Pension Changes Controversial?

The reforms have generated considerable concern among pension specialists, estate practitioners, savers and families.

People Planned Their Retirement Under Different Rules

Many people were encouraged to leave money invested in their pensions for as long as possible. They may have organised their retirement spending, life insurance and estate planning on the understanding that their remaining pension would usually sit outside their estate.

Changing the treatment of pensions may leave some people feeling that the rules have been altered after they made long-term and irreversible financial decisions.

The Possibility of a Combined Tax Burden

Where a pension holder dies after age 75, beneficiaries may already face Income Tax on inherited pension withdrawals. Adding the pension to the estate for Inheritance Tax purposes creates the possibility of both taxes applying in connection with the same inherited fund.

More Work for Executors

Executors may need to identify every pension arrangement, obtain valuations from several providers, calculate how the pension interacts with the rest of the estate and communicate with beneficiaries who may be different from those named in the will.

Professional bodies have warned that personal representatives could face difficulties where pension information arrives late or where the pension beneficiaries are not the same people who inherit the rest of the estate.

Delays for Bereaved Families

Pension providers may need to delay or restrict payments while the estate’s potential Inheritance Tax liability is established. This could be particularly difficult for families who rely on the money for mortgage payments, funeral expenses, care arrangements or basic living costs.

Frozen Inheritance Tax Thresholds

The standard £325,000 threshold has remained unchanged for many years and is now frozen until 2031. As property prices, pension values and savings rise, more estates may be drawn into the Inheritance Tax system even where families do not consider themselves wealthy.

Supporters of the reform argue that pensions receive substantial tax advantages during a person’s lifetime and should not also provide an unlimited Inheritance Tax shelter. Critics respond that people saved into pensions responsibly and should not be penalised for dying before they were able to use their retirement savings.

The New Prime Minister’s Separate State Pension Tax Announcement

A separate pension-related announcement has also caused confusion.

The Burnham government has announced or restated an intention to protect pensioners whose only income is the basic or new State Pension from paying Income Tax as the value of the full State Pension approaches and potentially exceeds the frozen Personal Allowance.

For 2026–27, the full new State Pension is £240.30 per week, equivalent to approximately £12,495.60 over 52 weeks, while the standard Personal Allowance remains £12,570. The gap is therefore extremely small.

The State Pension remains legally taxable income under the existing general rules. A person normally pays Income Tax when their combined taxable income exceeds their available Personal Allowance.

Reports concerning the new government’s approach indicate that pensioners whose sole income is the State Pension will be protected from paying tax. However, the announcement has attracted criticism because someone with even a small private pension, workplace pension, widow’s pension or other taxable income may not receive the same protection. Critics have described this as potentially creating a complicated two-tier system between pensioners with only the State Pension and those who saved a modest additional amount.

This State Pension announcement is not the same policy as the pension Inheritance Tax reform. One concerns Income Tax while a pensioner is alive; the other concerns the treatment of unused private pension funds after death.

Further legislation and official implementation details will be required before it is possible to determine precisely how the State Pension protection will operate.

How Could the Changes Affect Disabled People and Their Families?

Life insurance and pension death benefits are not always about transferring wealth to already affluent relatives.

Many parents and carers use these arrangements to provide future security for:

Disabled children or adult dependants.
A partner who cannot work because of illness or disability.
Someone who requires specialist accommodation or ongoing care.
A family member who receives means-tested benefits.
A person who may not be able to manage a large sum of money independently.

An inheritance or insurance payout can also affect entitlement to means-tested benefits, depending on how the money is received, held and used. Families supporting vulnerable beneficiaries should therefore obtain specialist advice covering tax, trusts, benefits, mental capacity and long-term care planning.

A trust intended to protect a disabled or vulnerable beneficiary must be designed carefully. A poorly drafted arrangement could create unexpected tax consequences, affect benefits or leave trustees without clear instructions.

What Should People Do Now?

People should not panic, withdraw their entire pension or transfer valuable assets solely because of headlines about a “death tax”.

However, it would be sensible to review existing arrangements before April 2027.

Consider checking:

Whether your will remains up to date.
Who owns your life-insurance policy.
Whether your life insurance is written in trust.
Who is named on your pension expression-of-wish or nomination form.
Whether your pension provider has your current family details.
The approximate combined value of your property, savings, investments, insurance and pensions.
Whether a spouse or civil-partner exemption may apply.
Whether provision has been made for a disabled or financially dependent beneficiary.
Whether your executors know where your policies and pension documents are stored.

An expression-of-wish form does not necessarily operate in the same way as a will. Pension trustees may retain discretion over who receives the benefit, so nomination forms should be kept accurate and regularly reviewed.

People should also avoid making major pension withdrawals without advice. Taking money out of a pension can create an immediate Income Tax bill and may move money from a previously protected pension arrangement directly into the person’s taxable estate.

Conclusion

The phrase “death tax” can make it sound as though grieving relatives automatically receive a tax bill simply because someone has died. In reality, Inheritance Tax is normally calculated against the deceased person’s estate and paid by the executor before the inheritance is distributed.

Life-insurance payouts are not usually treated as ordinary income in the hands of the beneficiary. However, a policy paid into the deceased person’s estate can increase the estate’s value and may therefore contribute to an Inheritance Tax liability. Writing a suitable policy in trust can sometimes keep the proceeds outside the estate, but professional advice is essential.

The most significant forthcoming change is that, from 6 April 2027, most unused private pension funds and pension death benefits will be brought into the Inheritance Tax calculation. Although the current Prime Minister, Andy Burnham, has inherited the policy, it was originally introduced and legislated for under the previous government.

The controversy is not simply about whether wealthy estates should pay more tax. It concerns fairness, retrospective retirement planning, frozen thresholds, administrative delays and the possibility that some inherited pensions could face both Inheritance Tax and Income Tax.

Families should therefore review their wills, pensions, insurance policies and beneficiary arrangements while they still have sufficient time to make informed decisions.