The pension mistake that could leave your family with a tax bill they can’t pay

Millions assume their pension will pass to loved ones tax-free. From 2027 that changes, and experts warn some families could be left with a bill they have no quick way to pay

Families have been warned over a little-known pension change that could leave them with an inheritance tax bill they have no easy way to pay.

The mistake is a common one: assuming your pension will pass to your loved ones tax-free, as it largely does now.

From 6 April 2027, that changes. And for some families, it means a large tax bill with no obvious way to settle it.

What’s changing

Under new rules, now law, most unused pension pots and pension death benefits will count as part of your estate for inheritance tax (IHT) for the first time. Anything above the tax-free threshold is taxed at 40%.

It’s a big shift. Until now, most pensions have passed outside the estate, free of IHT. It’s why so many people assume theirs is safe. From 2027, for many, it won’t be.

Who it hits

The Government estimates around 10,500 estates will be dragged into paying IHT for the first time in 2027-28. A further 38,500 that already pay it will face bigger bills, around £34,000 more on average. The change is expected to raise more than £1billion a year by the end of the decade.

Most people still won’t pay. HMRC says more than 90% of estates will face no inheritance tax even after the change. The tax-free band is £325,000, rising to £500,000 if you leave a home to your children or grandchildren, and up to £1million for couples. Anything left to a husband, wife, civil partner or charity is exempt.

But a big pension is exactly the sort of thing that can tip an estate over the line.

Over-75s face an even bigger hit. If you die aged 75 or over, your family also pays income tax, up to 45%, on whatever they take from the inherited pension, on top of the 40% IHT. Experts say the combined bill can swallow around two-thirds of the pot.

The bill they can’t pay

The biggest problem is timing. IHT usually has to be paid within six months of death, with interest on anything late.

But the person sorting out the estate often can’t get at the pension quickly enough to pay the bill it has caused. And unlike a house, a pension can’t be paid off in instalments over 10 years.

Take a £500,000 pension left on top of an estate that has already used up its allowances. That pension alone could trigger a £200,000 tax bill, due within months, while the money is still locked in the scheme.

A House of Lords committee said it was “not realistic” to expect families to meet the six-month deadline when pensions are involved, and called for them to be given at least a year to pay.

“An admin nightmare is waiting in the wings for grieving families,” warned Maike Currie of pension firm PensionBee, with relatives left to track down old pension pots before they can even work out the bill.

How to protect your family

Howard Gregory, life insurance expert at Life Pro, says this is exactly the gap life insurance is built to fill.

“The cruel part is the timing,” he said. “The bill can land within months of a death, but the money to pay it is often locked inside the very pension being taxed. Families end up asset-rich but cash-poor at the worst possible moment.”

He says a policy written in trust can be the answer. “It pays out a tax-free lump sum quickly, straight to the people you’ve named. That gives them the cash to settle a bill like this without waiting months to get at a pension, or selling the family home.”

The trust is the key bit. “Writing it in trust keeps the payout outside your estate, so it isn’t taxed itself, and it reaches your family fast instead of getting stuck in probate.”

He says it isn’t right for everyone. “Everyone’s situation is different, so it’s worth talking it through with a financial adviser. But having tax-free cash ready to go is often what stops an inheritance tax bill turning into a crisis.”