Families face a bigger tax bill as pensions join the estate

People relying on their pension to pass wealth to the next generation should review their plans now, as unused pension funds are set to fall within inheritance tax from 6 April 2027, warn Banbury accountants and business advisors Whitley Stimpson.

For many years pensions have sat outside the estate for inheritance tax purposes, making them one of the most effective ways to leave money to children and grandchildren. Many savers have deliberately spent their other savings first and left their pension untouched for exactly that reason.

That approach changes for deaths on or after 6 April 2027, when most unused pension funds and death benefits will be counted as part of the estate and taxed at up to 40% above the available allowances. The government estimates that around 10,500 estates a year will face an inheritance tax bill for the first time as a result, with a further 38,500 paying more.

The impact is sharpest where someone dies aged 75 or over, because beneficiaries already pay income tax at their own rate when they draw money from an inherited pension. Once inheritance tax is taken first, a higher rate taxpayer could see more than 60% of the pension go in tax.

Some important protections remain in place under the new rules. Pensions left to a spouse or civil partner stay free of inheritance tax, death in service benefits are excluded and the £325,000 nil rate band still applies to the estate as a whole.

Responsibility for paying any tax due will fall on the personal representatives handling the estate, although they and the beneficiaries can ask the pension scheme to pay the bill directly from the fund where the tax is £1,000 or more. Executors can also ask the scheme to hold back up to half of the benefits for up to 15 months while the tax position is worked out.

Mike Shearan, Senior Tax Manager at Whitley Stimpson, said: “For many families the pension has quietly become the biggest asset they plan to pass on, and many people are not yet aware that from April 2027 it will sit inside the estate.

“Depending on age and circumstances, it may make sense to rethink how much more goes into a pension, or to start drawing on it earlier and use the money in other ways, such as gifting to family or investing elsewhere. These are not decisions to rush, because taking money out of a pension carries its own income tax cost and most gifts need seven years to fall fully outside the estate.

“That is why the lead time matters so much as estate planning works best when there is time to put the right arrangements in place With less than six months to go before these changes come into play, now is the moment to take advice and look at the whole picture.”