Unspent pension savings will be brought inside the inheritance tax net from April 2027 after changes announced in the 2024 Autumn Budget. This could see some families paying an effective tax rate of 67%.
Double taxation is to blame. On top of any inheritance tax liability, beneficiaries will have to pay income tax on pension withdrawals that exceed the personal allowance, unless the original pension holder died before age 75.
Due to the way the tax is deducted, this will create an effective tax rate of 52% for basic-rate taxpayers, 64% for higher-rate taxpayers, and 67% for additional-rate taxpayers.
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How does pension double taxation work?
Imagine you inherited a pension worth £100,000 from someone who died after age 75 and who had already used up their tax-free allowances (known as the nil-rate bands) on other assets. First of all, you would have to pay a 40% inheritance tax bill, taking the value of the pot to £60,000.
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Any withdrawals from the remaining £60,000 would be taxed at your marginal rate – 20% for basic-rate taxpayers, 40% for higher-rate taxpayers and 45% for additional-rate taxpayers.
- Basic-rate taxpayers: Twenty percent of £60,000 is £12,000, so you would be left with £48,000 after tax. In other words, the taxman takes 52p in every pound.
- Higher-rate taxpayers: Forty percent of £60,000 is £24,000, so you would be left with £36,000 after tax. The taxman takes 64p in every pound.
- Additional-rate taxpayers: Forty-five percent of £60,000 is £27,000, so you would be left with £33,000 after tax. The taxman takes 67p in every pound.
As the above figures show, the IHT changes have significant implications for your estate planning. Pensions have gone from being one of the most tax-efficient vehicles for IHT planning to potentially one of the least tax-efficient.
Those whose estate is close to £2 million in value should be particularly careful, as you start to lose a valuable tax-free allowance (the residential nil-rate band) at this point. This is worth £175,000, and can be used alongside your regular £325,000 nil-rate band if you are leaving the family home to a direct descendant.
If you are close to the £2 million threshold, your pension assets could push you over the line once the new rules kick in from April 2027.
Against this backdrop, more retirees are withdrawing bigger sums from their pensions to avoid losing their savings to the taxman.
Surge in pensioners taking more from their pensions
Financial advisers are reporting a surge in clients taking more from their pensions ahead of the retirement funds becoming subject to inheritance tax, according to new research from advice firm Wesleyan.
The vast majority (90%) of advisers polled said they had seen an increase in clients speeding up their pension drawdown in anticipation of the reform, in a survey of 300 UK-based financial advisers conducted between 24th March and 30th April 2026.
Three quarters (74%) said clients are typically increasing their annual pension withdrawals by between 5% and 15% due to IHT concerns. Nearly a fifth (18%) said retirees are upping withdrawals by more than 16%.
Advisers have flagged the long-term impact of higher amounts of pension drawdown on retirees ’ finances: 90% of advisers said they were concerned about the volatility drag (90%) – where market fluctuations erode returns over time – and sequencing risk (88%) – the danger of poor investment returns early in retirement reducing the sustainability of withdrawals.
Karen Blatchford, managing director of distribution at Wesleyan said: “While it’s understandable clients are looking to act ahead of inheritance tax changes, advisers know that increasing withdrawal levels can have significant consequences, especially in the uncertain and volatile market conditions we’re experiencing today.
“That makes it vital that any changes to withdrawal strategies are supported by robust planning and advice to help clients maintain long-term financial resilience.”
Retirees are also weighing up which assets to draw down first, and which tax wrappers to contribute to in the first place. Drawing on ISA wealth before your pension used to be the obvious route, as pensions were exempt from inheritance tax while ISAs were not. The upcoming changes have complicated the picture.
Should you change your retirement plans to reduce your IHT bill?
Pensions are still the best way for most people to save for retirement thanks to the tax relief and employer contributions you get if you’re employed. It is usually a bad idea to stop or reduce your contributions, as you still need to build retirement income.
If you’re retired and are comfortable that you will have excess savings left over after you die, consider upping your pension spending. This could allow you to leave other assets like ISAs untouched, which could then be given to your loved ones instead of your pension after you die.
Like pensions, ISAs are still subject to IHT but your beneficiaries won’t have to pay income tax when they withdraw money from an inherited ISA. This could be particularly beneficial if they are an additional-rate taxpayer, likely to fall victim to the 67% tax trap. Just remember that ISAs are not as tax-efficient as pensions on the way in, as you do not benefit from tax relief on contributions.
Also be mindful of your own tax considerations, as upping your pension withdrawals could mean you end up paying more income tax yourself.
“We would always advise clients to consider the income tax they will pay when planning pension withdrawals, but this question is becoming more important now that more savers are looking to take greater amounts out,” said Gary Smith, financial planning partner at Evelyn Partners.
“Those now looking to spend or gift more of their pension funds need to keep an eye on the tax they will pay as they withdraw funds, because that is a definite liability they will have to pay, whereas in some instances the IHT might only be a notional future problem,” he added.
“If possible, keeping one’s taxable income on the right side of the next tax band can make sense, so for many people this might mean measuring their pension withdrawals so they do not push total annual income above £50,270 into higher-rate tax at 40%.”
Gifting to reduce your inheritance tax bill
You could also consider giving some of your pension wealth away in your lifetime to reduce your IHT bill. There are strict rules around gift-giving, but everyone has an annual gifting allowance of £3,000. Anything more than this, and you will usually need to outlive the gift by seven years to avoid IHT, known as the seven year rule.
There is also an exemption for regular gifts made out of “surplus income”, so you could consider something like setting up a direct debit into a grandchild’s Junior ISA. Don’t overdo it though; nobody knows how long they will live and it is important to consider future expenses like the cost of care.
