From April 2027, pensions will be subject to inheritance tax, and experts warn that families could face tax bills larger than the money they actually receive because pension investments won't qualify for inheritance tax loss-on-sale relief, unlike shares and property held directly.
Financial experts have explained the situations families could face at an already difficult time as they deal with the loss of a loved one, noting it could leave them with a major headache and even become contentious.
HMRC estimates on affected estates
HMRC estimates that, of the taxpaying estates affected by the reforms in tax year 2027 to 2028, the pension component makes up less than 5% of the net value of the estate in more than half of cases and less than 60% of the estate in almost all cases.
Scott Gallacher, director of Leicester-based Rowley Turton, said: "While unlikely to be a common occurrence, in certain circumstances inheritance tax could exceed the value of pension funds ultimately received, particularly where higher-risk investments suffer substantial losses following death. Who bears that shortfall could become contentious, especially where beneficiaries have little control over the investments."
Concerns over pension investment management
Gallacher added: "Pension trustees, providers and advisers will need to reconsider how pension investments are managed following death. Leaving everything invested may no longer be appropriate, particularly where there's a substantial IHT liability."
He also noted that commercial property and other illiquid investments present an even greater challenge, as selling quickly may be impossible or financially damaging. "Ultimately, I believe HMRC should extend IHT loss-on-sale relief to pensions. Otherwise, families could face tax bills based on wealth they never actually receive," he said.
Tax on money 'you don't even receive'
Rikesh Bhatt, founder and financial planner at Telford-based 8 Financial Planning, said: "Nobody should pay inheritance tax on money their family never actually receives. From April 2027 that can happen with pensions, because the tax is based on the value at death, not on what's left when it's finally paid out."
Bhatt added: "Shares and property held directly can get loss-on-sale relief, so pensions should too and HMRC should fix that before the rules start rather than after families get caught out. I wouldn't make selling everything straight after a death the default either, because that can turn a short-term dip into a permanent loss."
He advised: "The better answer is planning while you're alive: know roughly what the IHT bill on your pension could be, think about where the money to pay it will come from and keep your nominations up to date. SIPPs holding commercial property need the most thought, because you can't sell a building in a few weeks to meet a tax bill."
'Serious flaw' in new HMRC rules
Nouran Moustafa, practice principal and Independent Financial Adviser at Roxton Wealth, said: "Imagine inheriting a £1 million pension, watching its value collapse, and discovering HMRC still expects tax based on its original value. That's a serious flaw in the new inheritance tax rules."
Moustafa explained that from April 2027, pensions will generally be valued at death for inheritance tax, without loss-on-sale relief if investments subsequently fall. Personal representatives are responsible for paying the tax, with beneficiaries potentially sharing liability.
She added: "But automatically selling investments after death isn't necessarily the answer. It could crystallise losses unnecessarily. For SIPPs holding commercial property, the problem is even worse. You can't simply sell a building overnight to pay HMRC. I'd support extending appropriate loss-on-sale relief to pensions. The government shouldn't collect inheritance tax on wealth that no longer exists when beneficiaries receive it."
'Not HMRC's mistake the fix'
Harvey Dhillon, founder and CEO at Zmartly, said: "Yes, from April 2027 the tax on a pension can end up bigger than the fund itself, though only after a steep fall. The pension is valued just before death and the bill doesn't shrink when the fund does."
Dhillon noted that if the fund can't cover it, the executors can be made to pay the gap from the rest of the estate, so it can land on whoever inherits the house or the savings. "The law keeps the scheme's trustees out of the tax bill," he said.
He added: "Whether to sell fast, or sue, is for an adviser or a lawyer. Own a commercial building directly and the tax on it can be paid in 10 yearly instalments. Inside a SIPP the whole bill falls due within months, sold or not, but it can be paid from money outside the pension, so line that up early. Leaving pensions out of loss relief is a mistake. But it isn't HMRC's to fix: the relief is written into tax law, so changing it takes the Treasury and a Finance Bill. The latest Budget announced tweaks to the new rules and still didn't fix it."
An HM Treasury spokesperson said: "Around 90 per cent of estates each year will continue to pay no inheritance tax after the reforms. Loss-on-sale relief applies where certain assets owned by the deceased, such as property or shares, are later sold at a loss. That isn't what happens with a pension, so the relief doesn't apply in the same way."
