Please note: This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
Keep in mind that financial decisions depend on individual circumstances. An option that is suitable for one person, may not be appropriate for another person when their objective, risk tolerance, tax position, and personal circumstances are considered.
From 6 April 2027, many unused pension pots will be included in Inheritance Tax (IHT) calculations.
Since the government announced the change in the 2024 Autumn Budget, an increasing number of people have opted to withdraw their tax-free lump sum from their pension as soon as they can.
Currently, you can access your pension from age 55 (rising to 57 from April 2028). According to MoneyWeek (9 April 2026), the number of 55-year-olds taking their lump sum reached a five-year high in 2024/25.
However, while many people may be hoping to reduce their pension’s IHT liability, taking funds early might not be as tax-efficient as you think. Not only could funds still be subject to IHT if they remain part of your estate, but they could also be subject to other taxes – depending on how you use them.
Before rushing to withdraw your lump sum, it’s important to take a step back and carefully review your financial plan. Here are five questions you should answer before making a decision.
1. Will your estate be liable for Inheritance Tax?
While most unused funds in defined contribution (DC) pensions will be included in IHT calculations from April 2027, that doesn’t necessarily mean any tax will be due.
As of 2026/27, IHT is only charged on the portion of your estate exceeding your nil-rate band:
- The standard nil-rate band is £325,000.
- You may have a residence nil-rate band of £175,000 if you leave a primary residence to a direct descendant, bringing the total you can pass on before IHT is applied to £500,000.
- If you’re married or in a civil partnership, you can usually share your nil-rate band with your partner – meaning you may be able to pass on up to £1 million before your estate is subject to IHT.
The portion of your estate exceeding your nil-rate band is typically taxed at 40%.
It’s worth considering that your pension pot is likely to reduce as you draw down an income, depending on how long you live.
2. Would the withdrawal be subject to Income Tax?
You can generally withdraw a portion of your pension without being charged Income Tax. As of 2026/27, this is capped at 25% of your total funds, or the £268,275 Lump Sum Allowance, whichever is lower.
After you have taken your tax-free lump sum, withdrawals are typically subject to Income Tax at your marginal rate.
So, if your total income means you exceed the higher-rate threshold, a portion could be liable for Income Tax at the same rate as IHT (40%).
If you only take your tax-free lump sum, it’s worth considering that more of your withdrawals in retirement will be charged Income Tax, as you’ve used up your tax-free allowance.
3. How do you intend to use the money?
When funds are invested in a pension, growth is generally exempt from Capital Gains Tax (CGT) and Dividend Tax. Income Tax is only charged once you draw down more than your tax-free lump sum.
However, taking money from your pot early could result in it being taxed outside of your pension.
- Investing: Investments held outside of a pension may be subject to CGT, Dividend Tax, or Income Tax. While you can invest some funds tax-efficiently using a Stocks and Shares ISA, this is capped at £20,000 a year.
- Saving: Interest earned on savings may be liable for Income Tax if you exceed the Personal Savings Allowance. In 2026/27, this is charged at your marginal rate, but rates will rise by two percentage points from April 2027. You can save up to £20,000 a year tax-efficiently using a Cash ISA, or £12,000 a year for under-65s from April 2027.
- Gifting: Some gifts may still be included in your estate for IHT purposes if you pass away within seven years of gifting. You can make some gifts tax-efficiently, such as by using the £3,000 annual exemption.
Ultimately, removing funds from your pension isn’t necessarily the most tax-efficient option. If the money remains in your estate when you die, it may still be liable for IHT.
4. How might a large withdrawal affect your long-term income?
Without careful planning, taking funds from your pension early could leave you short of your required income in retirement.
As a result, you may have to adjust your lifestyle or risk running out of funds later in retirement.
A financial planner can help you calculate how much income you could need in retirement, based on your ideal lifestyle, tax liabilities, and average inflation. Once you understand how much you’re likely to spend, you can determine whether you can afford to withdraw from your pension early.
5. Are there other strategies you could use to reduce Inheritance Tax on your pension?
Naturally, you want to pass as much of your wealth as possible on to your chosen beneficiaries.
There are a few ways you can help reduce the IHT charged on your pension and wider estate:
- Spend your pension in your lifetime: In retirement, you will likely draw a regular income from your pension. By pacing your income to ensure it lasts throughout retirement, without leaving a large sum remaining in your pot when you die, you can help reduce the chances of your pension being subject to IHT. A financial planner can help you define a sustainable level of retirement income to meet your needs.
- Make gifts in your lifetime: Gifting your wealth can be an effective strategy to reduce your taxable estate. Gifts made outside of your tax-efficient allowances may still be included in IHT calculations for seven years. However, provided you made the gift more than seven years before your death, the full amount will usually be removed from your estate.
- Purchase an annuity: Annuities allow you to exchange a portion of your pension for a guaranteed retirement income, reducing the size of your pension for IHT purposes. That said, it’s important to note that you may receive less from an annuity than you paid in, depending on when you pass away.
- Leave your pension to your spouse: Typically, assets left to your spouse or civil partner are exempt from IHT. As such, you might consider leaving your pension to your partner. Pensions are not usually covered by your will, so you may need to complete an expression of wish form with each pension provider to assign a beneficiary.
These strategies might not be appropriate for all circumstances. It’s important to consult with a financial planner for guidance before making any irreversible decisions that could affect your finances.
Please contact us if you have any questions about how the IHT changes could affect your retirement plan and tax liability.
Please note: Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
