Former pensions minister: AI misread inheritance tax rules as pensions are brought into scope
Steve Webb says artificial intelligence was partly correct but pensions will count toward inheritance tax from April 2027 and can be used pro rata to meet the bill
A reader who used an artificial intelligence tool to estimate an inheritance tax bill was given a partially correct answer but drew a flawed conclusion, former pensions minister Steve Webb wrote, as new rules will bring pensions into the scope of inheritance tax from April 2027.
The reader’s example showed a household with a house worth £625,000, £40,000 in cash, £32,000 in cars and debts of £32,000, plus a £900,000 pension pot. After assuming the cars would be sold to clear the debts, the reader told AI the estate comprised £625,000 in property, £40,000 in cash and the £900,000 pension. The AI reportedly concluded the pension, being held in trust, could not be used to meet the estate’s inheritance tax (IHT) bill, leaving the heirs facing a large tax shortfall and the likely sale of the family home.
Webb, now a partner at consulting firm Lane Clark & Peacock and the long-running pensions agony uncle for This Is Money, said the AI’s factual starting point was right: many pension pots sit in trust and are not part of the legal estate governed by a will. But he warned that it is incorrect to conclude none of the pension can be used to meet an inheritance tax bill.
Under changes taking effect from April 2027, pensions will be treated as part of a deceased person’s overall estate for the purpose of calculating IHT. Webb said that when the government allocates an IHT bill under the new rules, it will do so on a pro rata basis across the different elements that make up the estate, and that allocation will include the pension.
Using the reader’s figures, Webb calculated a gross estate of £1,565,000 and noted that transfers between spouses are exempt from IHT. He explained that in the scenario where one partner dies and leaves everything to the surviving spouse, the couple’s combined IHT allowances (the basic nil-rate band and the residence nil-rate band) could amount to around £1 million by the time the surviving spouse dies and leaves assets to the children. Based on those assumptions, Webb said the estate would face roughly £226,000 in IHT when the second partner dies.
Because the £900,000 pension represents about 57.5 percent of the reader’s total assets, Webb said that roughly 57.5 percent of the £226,000 tax bill—about £130,000—would be attributed to the pension under the pro rata allocation. He said beneficiaries can ask the pension scheme to deduct the IHT share from the pension payout before distribution, meaning part of the tax bill can, in practice, be met from the pension pot.
That leaves the remainder of the bill—about £96,000 in Webb’s example— which could be met from cash, sale of other assets or by beneficiaries using funds from their inherited pension benefits. Webb noted the reader’s £40,000 in cash would reduce that shortfall to roughly £56,000, and heirs could choose to use pension withdrawals to settle the remaining amount rather than selling the family home.
Webb cautioned that the tax treatment of pension withdrawals depends on the age of the deceased and the type of pension arrangements in place. He said that if a pension holder dies before age 75, pensions may be paid tax-free. If the holder dies aged 75 or over, beneficiaries generally pay income tax on withdrawals at their marginal rate; in some cases readers assume a 20 percent rate for planning but individual rates will vary.
The former minister also addressed the reader’s thought that taking the 25 percent tax-free lump sum now would simplify matters. He said he could not give personal financial advice but explained that the 25 percent tax-free cash cannot be taken after death. Taking tax-free cash now would not change the IHT bill, because the cash would remain part of the estate for IHT purposes, but any invested cash received before death could be paid to heirs free of income tax on withdrawal depending on circumstances.
Webb warned about the broader limitations of relying on AI for financial planning. He said AI tools can “hallucinate” and return incorrect information. He advised users to ask AI tools for sources—preferably official ones such as gov.uk—and to experiment with different phrasings to check for consistency in answers. Webb recommended independent human financial advice for complex cases, particularly for households with assets well above £1 million.
The column reiterated that nothing in Webb’s responses constitutes regulated financial advice. Readers seeking personal guidance were directed to email pensionquestions@thisismoney.co.uk to pose questions to Webb’s column and to the government-backed MoneyHelper service, which provides free pensions assistance at 0800 011 3797.
Webb’s exchange highlights both a substantive policy shift and a practical lesson about technology: the incoming April 2027 rule change alters how pensions are treated for IHT and means that automated tools can mislead if outputs are interpreted without verification. He urged people to treat AI as a starting point for research rather than a substitute for professional, personalised guidance.
