There’s been a lot of noise recently about pensions and inheritance tax (IHT).
Draft legislation has been published for inclusion in a future Finance Bill that would bring unused pension pots into the IHT net from 6 April 2027.
So, it’s natural to ask: should you be withdrawing your pension now to save tax later?
Let’s walk through the key points before you make any big decisions.
First things first – don’t panic
The most important point is that this change is not yet law.
Even if it does go ahead, it won’t take effect until 6 April 2027. So there’s no need to rush into withdrawing large sums from your pension.
On top of that, there’s constant speculation that future Budgets may bring more pension changes – but we simply don’t know yet what those will look like.
For now, the key is to understand the rules as they stand and think about how they might affect you.
When can you access your pension?
If you’ve got a money purchase (defined contribution) pension, you can usually start accessing it from age 55.
This minimum age is set to rise to 57 from 6 April 2028.
Taking money before age 55 (or 57 after April 2028) is treated as an unauthorised payment. That can trigger a hefty tax charge of up to 55%. In many cases, that’s likely to be worse than any IHT you might be trying to avoid.
So, taking your pension early purely to “beat” IHT is very unlikely to be a good move.
The tax-free lump sum – and what happens next
Once you’re old enough to access your pension, you can usually take 25% of your pension pot tax-free, subject to an overall cap of £268,275.
After that, any further withdrawals are taxed at your marginal rate of income tax – so that could be 20%, 40% or 45%, depending on your income level.
This is where the comparison with IHT becomes important.
- If you’re a higher or additional rate taxpayer, withdrawing more than the tax-free lump sum often means paying 40% or 45% income tax.
- That may be no better – and possibly worse – than a 40% IHT charge if the funds stayed in your pension and were taxed on death.
So, for many people, there’s no clear tax win from pulling money out of the pension just to avoid potential IHT.
Don’t forget the money purchase annual allowance (MPAA)
Once you’ve flexibly accessed your pension (for example by taking taxable withdrawals, not just the tax-free lump sum), your ability to pay into pensions in the future is restricted.
You’ll usually be limited by the Money Purchase Annual Allowance (MPAA), which is currently £10,000 per year, if that’s lower than your earnings.
If you take large withdrawals now and later want to rebuild your pension, this cap can really get in the way.
Who will inherit your pension?
Before you withdraw anything for IHT reasons, ask:
Who will actually inherit my pension if I die with money still in the pot?
If your spouse or civil partner is the beneficiary, then the spouse exemption normally means no IHT is due on those funds anyway.
In that case, there’s no IHT saving to be had by withdrawing the money. You could end up paying income tax now to avoid an IHT bill that wouldn’t have existed in the first place.
Will your estate even be liable to IHT?
Next, look at the overall value of your estate, including:
- Your home
- Savings and investments
- Other assets
- Any unused pension pots, if the new rules go ahead
Ask yourself:
Will my estate actually exceed the available nil rate bands and exemptions?
If your estate is below the IHT threshold, or covered by allowances such as:
- The £325,000 nil rate band
- The residence nil rate band (where applicable)
- Exempt transfers to a spouse or civil partner
…then there may be no IHT to save by drawing funds out of your pension.
Look at all the tax charges – not just IHT
It’s really important not to look at IHT in isolation.
Here’s what can happen if you’re not careful:
- You withdraw money from your pension.
- You pay income tax on those withdrawals (after the tax-free lump sum).
- You don’t spend or gift the money – it stays in your estate.
- On death, those leftover funds are still counted when working out IHT.
In other words, if the money just sits in your bank account, it could face two layers of tax:
- Income tax when you withdraw it
- IHT when you die
That’s the opposite of tax-efficient planning.
What about gifting the money?
You might be thinking of withdrawing funds and then passing them on during your lifetime.
There are two main routes here:
- Regular gifts out of income
If you take regular pension income and pass it on, it may be covered by the “normal expenditure out of income” exemption, as long as:
- The gifts come from surplus income, and
- You’ve still got enough income left to maintain your usual standard of living.
If your income tax rate on those withdrawals is less than 40%, there could be a tax advantage compared with leaving the money in your estate to suffer IHT at 40%.
- Lump sum gifts
If you take a lump sum from your pension and make a one-off gift of capital, that’s normally a potentially exempt transfer (PET) for IHT.
You’ll need to survive seven years from the date of the gift for it to fall out of your estate completely.
Of course, there’s always the chance the Chancellor could change the rules again – including the way lifetime gifts are treated – in future Budgets.
So, should you withdraw your pension to save IHT?
There isn’t a one-size-fits-all answer.
The right approach depends on:
- Your age and health
- The size of your pension and overall estate
- Who you want to benefit from your wealth
- Your current and future income tax position
- What future changes the Chancellor may announce
In many cases, taking large withdrawals purely for IHT reasons can backfire, especially if:
- You pay higher or additional rate income tax on the withdrawals, and
- The funds still end up in your estate at death.
Our view – take advice before you act
The key message is simple:
- Don’t rush to raid your pension just because of draft legislation.
- Do take time to review your overall position and understand your options.
If you’re wondering whether you should withdraw your pension to reduce IHT, let’s talk it through.
Get in touch with us and we’ll help you weigh up the numbers, the risks, and the alternatives – so you can make a decision that works for you and your loved ones.
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Any questions?
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