Why pension gurus warn Britain is hurtling towards an inheritance tax ‘catastrophe’ that will hammer millions of families… and what you need to do about it NOW

Bereaved families will soon be lumbered with daunting new bureaucracy that will cause misery, extra costs and the risk of heavy fines, money experts are warning.

The avalanche of red tape is being caused by pensions being drawn into the inheritance tax net from spring 2027. Crucially, this will create admin headaches even for families with no bill to pay.

It means sorting out an estate is set to become far more onerous because families will have to chase up pension companies for vital information.

Stiff late payment charges could be levied if you fail to track down all pensions, and work out and settle the bill within six months.

Inheritance tax also has to be paid upfront before you can access or receive a penny from a loved one’s estate – already a heavy burden for many relatives.

Even when no inheritance tax is due, a deceased person’s finances still need to be examined and information must often be submitted anyway to prove that to the taxman.

‘Proposing to make bereaved relatives find all the pensions, identify who will inherit, then calculate and pay the inheritance due within six months is unworkable,’ says former Pensions Minister Ros Altmann.

‘There have not been enough warnings about this coming catastrophe.’

Steve Webb, also a former Pensions Minister and now a partner at pension consultants LCP, says: ‘Life is tough enough when you have just lost a loved one without having extra layers of bureaucracy on top.

‘Complications will no doubt arise where the family member cannot track down all of the deceased person’s pensions, or where providers are slow to supply the information needed to work out the inheritance tax bill.’

Here’s what lies ahead – and what you can do to protect your loved ones now.

WHAT IS CHANGING?

Chancellor Rachel Reeves announced at last year’s Budget that inheritance tax would start being levied on unspent pensions, as it is on other assets such as property, savings and investments, from April 2027.

You can pass on up to £325,000 tax-free if you are single, or £650,000 jointly if you are married. There is a further £175,000 allowance, which increases the threshold to £500,000 – or a joint £1 million if you have a partner – if you own a property, and intend to leave money to your direct descendants.

Once an estate reaches £2 million, this own-home allowance starts being removed by £1 for every £2 above this threshold, and it vanishes completely by £2.3 million.

Everything above your threshold is charged at a drastically high 40 per cent – and from April 2027 that will include pensions as well.

There has been widespread criticism that families will face a ‘double tax’ hit under the plans.

Those who die after the age of 75 will see their pots hit by both inheritance tax and the income tax already levied on beneficiaries, who have to pay their normal rates of 20 per cent, 40 per cent or 45 per cent on pension withdrawals.

The Government originally intended pension schemes rather than ‘personal representatives’ – meaning executors or administrators of an estate, who are often family members – to be liable for the reporting and payment of any inheritance tax on pensions. 

But instead, it has now been decided to make personal representatives, who are already responsible for administering the rest of the estate, liable for reporting any inheritance tax due on pensions and death benefits.

The personal representatives, alongside the beneficiaries inheriting the estate, are jointly responsible for paying the bill, either as a group or individually.

SIX-MONTH TIME LIMIT

You get just six months, kicking off from the last day of the month after a loved one’s death, to add up their assets, calculate what is owed and hand over any money due to the taxman.

If you are late, the estate will be charged interest – it is currently 8 per cent a year. If no money is due, you get 12 months to simply fill in the forms to show nothing is owed.

But you will need to settle this issue one way or another with HMRC – if you need to get probate to gain control of the deceased person’s funds, it won’t be granted without the taxman’s sign-off.

Baroness Altmann says it will be an impossible task for some families to find all past pensions, identify all beneficiaries, work out and then pay any inheritance tax due within six months.

‘Many personal representatives or executors of someone’s will are just family members, with no experience in pensions or tax, and they will be doing all this work unpaidc she says.

‘These pension burdens on ordinary bereaved relatives are wholly disproportionate.

‘Nobody would want to be an executor or personal representative once they realise what these new rules mean.’

Pension schemes will have to verify their identity and authority, make reasonable enquiries about potential beneficiaries, and gather all necessary evidence before determining what will be paid to each person.

The representative will have to pay any inheritance tax inside six months, but potentially without any money from the pension funds available to them.

It is already common for beneficiaries not to have the ready cash to pay inheritance tax bills.

There are various ways to get round this, but they often arrange for cash in the deceased person’s accounts to pay HMRC direct, or borrow to cover the bill.

You can also pay in ten equal instalments spread over up to ten years, but the 8 per cent interest for late payments will then be applied.

Steve Webb says HMRC is going to have to give serious thought to the penalties around late payment of inheritance tax to ensure grieving families are not at risk if delays related to pensions are not under their control.

Charlotte Fox, senior associate at law firm Gardner Leader, also sounded the alarm. She says the six-month limit could prove challenging, particularly in cases of unexpected deaths, or complex finances. 

She adds: ‘Personal representatives are responsible for settling the estate, including any inheritance tax liability, but they do not control the pension fund unless they are also the nominated beneficiary or involved in the decision process.

‘Without additional legislative clarity and administrative reform, there is a risk of confusion, delays, and unintended tax consequences for estates and beneficiaries alike.’

Heather Rogers, owner of Aston Accountancy, adds: ‘Having the personal representatives liable for the inheritance tax on the inherited pension funds is unfair in its current form and a nightmare for any personal representatives handling such an estate.

‘The time limits are also very restrictive and add unnecessary pressure to all parties, and failure to get matters concluded in the timeframe could potentially give rise to claims against personal representatives.’

EMPTYING PENSIONS 

Mid-level earners who own their home and have some pension savings could be caught out by the new rules – and so, warns Baroness Altmann, will have a strong incentive to empty their pension fund as soon as they can and pay just basic rate income tax on it.

‘Someone with income of, say, £35,000 a year, can withdraw £15,000 from their pension and pay only 20 per cent tax, rather than risking losing 40 per cent of it if they die unexpectedly young,’ she says.

‘Most people are more worried about dying soon rather than living too long, and there will be a clear incentive to empty their pension fund, just in case the worst happens, rather than keeping it for later life.’

There is evidence this has already started to happen, according to Craig Rickman, pensions expert at DIY platform Interactive Investor.

‘People are already altering their behaviour ahead of April 2027, in some cases making pension withdrawals sooner than previously intended in fear of loved ones being hit with exorbitant tax bills and facing an administrative maelstrom. 

‘This could not only lead to poorer outcomes in retirement, but damage trust and confidence in a pension system that is already on shaky ground.’

Rickman is concerned that savers are extracting and passing on money from their pensions that they will eventually need themselves in future, for example to meet care bills.

TIME TO THINK AGAIN?

Witnesses to recent hearings of a House of Lords committee on the issue recommended urgent changes, according to Baroness Altmann, which she says would improve the current proposals but not undo all the damage.

One proposal is to extend the current inheritance tax payment deadline from six months to two years, to avoid 8 per cent interest being imposed before families have enough time to sort out pensions on top of the rest of an estate.

Another is to simply have personal representatives and pension schemes send all relevant information to HMRC, and make it responsible instead for calculating any tax due and liaising with the beneficiaries.

Other suggestions include making beneficiaries liable for the tax, rather than personal representatives, and allowing pension funds to pay the inheritance tax before probate – which gives access to a deceased person’s assets – is officially granted.

Baroness Altmann says a different plan entirely would be much less damaging – simply levying a flat-rate charge of 10 per cent, 15 per cent or 20 per cent on unused pensions when someone dies, paid direct by the pension firm regardless of the inheritance tax position of an estate.

‘No faffing about with inheritance tax forms. No 8 per cent interest on late payments. No incentive to take money out while still young, just in case,’ she says.

‘No headlines about widows or bereaved children bankrupted by the costs of trying to deal with pension tax consequences and beneficiary disputes involved in administering their loved one’s estate. Revenue raised could eventually be earmarked to help fund social care.’

No doubt her idea will divide opinion, as it would mean a new tax on the less well-off who otherwise would not face inheritance tax.

Meanwhile, Roddy Munro, pension specialist at financial services firm Quilter, warns that unless the current plans are simplified there is going to be a seismic shift in how people plan for retirement and inheritance.

‘How the policy is eventually enacted risks turning a targeted tax reform into an administrative minefield,’ he says. ‘What’s more, while only a small fraction of estates will pay more tax, a far greater number will face needless complexity, delays and stress – often at the worst possible time.’

The Government was asked for comment but did not respond before publication.

PROTECTING LOVED ONES

It is sensible to get your paperwork in order, with an up-to-date list of your assets and which financial and pension firms hold them, along with passwords, if necessary, and contact details.

Keep it with your will and lasting power of attorney in a secure place, such as a safe.

If you are already drawing on pensions you will have a good handle on the relevant information, but many younger savers lose track of funds held with old employers and have to hunt them down. Use the Government’s free service at gov.uk/find-pension- contact-details.

Some people merge pensions as a tidy-up exercise, but this option may not be open to you, or there might be penalties, so research this carefully first.

If you pull out pension cash to give away to family members then survive seven years it typically falls outside of the inheritance tax net, although this might change in the Budget.

Experts say you should balance this decision carefully against harming your own retirement.