How will pensions being counted for Inheritance Tax change your plan?

01 What the old rule did

Money still inside a pension on death sat outside the estate for Inheritance Tax, and where death occurred before 75 it could pass to beneficiaries free of Income Tax as well. That combination made an untouched pension the most efficient asset to die holding, and it drove the whole ordering of UK withdrawal advice.

The consequence was households living off ISAs and general investment accounts while a pension compounded untouched. The Institute for Fiscal Studies documented the behaviour and identified the exemption as the cause, which is part of why it was reformed.

None of that advice was wrong. It was correct for the rules in force, and it is the rules that are changing.

Source: Death and taxes and pensions

02 What replaces it

From April 2027, unused pension funds are due to be counted as part of the estate. For a spouse or civil partner nothing changes in practice, because transfers between them remain exempt without limit. For any other beneficiary the fund becomes chargeable at 40% above the available bands.

The Income Tax treatment on the beneficiary's side is unchanged, which is where the arithmetic gets hard. A non-spouse beneficiary of a fund from someone who died at or after 75 pays Income Tax at their marginal rate on withdrawals, and the fund may already have borne Inheritance Tax.

That is the case for drawing the pension down during life rather than preserving it, and it applies specifically to estates above the bands.

On the defaults above, the worked example shows £40,000. Counting the pension adds £40,000 of Inheritance Tax, before any Income Tax the beneficiary pays on withdrawals.

Source: Inheritance Tax

03 Who actually needs to act

A minority. Roughly one estate in twenty pays Inheritance Tax, and the bands available to a married couple with a home passing to children reach £1 million. Below that, the change has no effect and there is no reason to alter a withdrawal plan for it.

Where it does bite, the response is not dramatic. It is to use the annual allowances that were being left unused: draw pension income up to the personal allowance and, where the plan supports it, the basic-rate band, every year. That was worth doing anyway and is now worth more.

The instinct to empty a pension quickly is usually wrong. Withdrawing large amounts in a single year pushes income into the higher and additional rates, and 40% Income Tax now to avoid 40% Inheritance Tax later is not a saving.

The arithmetic that makes early drawing worthwhile is narrow, and it is worth stating rather than assuming. Money drawn at the basic rate costs 20% now against a possible 40% later, which is a clear gain. Money drawn at the higher rate costs 40% now against 40% later plus the beneficiary's own Income Tax, which is a smaller gain and only exists for a non-spouse beneficiary. Money drawn at the additional rate is usually worse than leaving it. So the band you are drawing into decides the answer, not the size of the estate.

Source: Income Tax rates and Personal Allowances

04 The interactions to check

Drawing more pension income raises your taxable income, which can affect the personal allowance taper, the High Income Child Benefit Charge and means-tested benefits. It also triggers the money purchase annual allowance if you are still contributing, which caps future contributions at £10,000.

Moving pension money into an ISA does not remove it from the estate — an ISA is fully chargeable — so the transfer buys tax-free growth rather than an Inheritance Tax saving. Gifting the withdrawn money does remove it, subject to the seven-year rule or the immediate exemptions.

And the expression of wish still matters. Beneficiary drawdown remains available, and who receives the fund and how they take it affects the Income Tax side even after the Inheritance Tax position changes.

Source: Tax on your private pension contributions

05 What to do before April 2027

Work out whether your estate, including pensions, exceeds the bands available to you. If it does not, do nothing. If it does, start using the personal allowance and basic-rate band on pension withdrawals now rather than at 75, and consider whether surplus income can fund regular exempt gifts.

Review the will and the expression of wish together, because the two interact and the second is usually decades out of date. And treat announced legislation as announced rather than enacted — the detail can move, and a plan that only works under one specific version of the rules is fragile by construction.

The durable version of the advice does not depend on the change at all: use every annual allowance you are given, because none of them carries forward.

One further thing is worth doing now and costs nothing: write down what the estate actually contains, pensions included, with a current value against each line. Most households discover on doing it that they are either comfortably below the bands or clearly above them, and that answer settles the whole question in an afternoon.

Source: Plan your retirement income