Some pension savers are taking out more money from their accounts, but doing so puts them at risk of depleting their funds or incurring high income tax rates
We go over safe ways to deal with the impending inheritance tax change.
There may be serious unforeseen consequences if retirees take out more money from their pension funds just to lower the size of their estate for inheritance tax (IHT) purposes.
As per the modifications revealed in the Autumn Budget, pensions will be subject to inheritance tax starting in April 2027.
In an effort to lower the possibility of leaving their loved ones with an inheritance tax bill, some savers are now looking for ways to spend down their pension funds more quickly than they had intended.
The wealth manager Rathbones tells BFIA that it has seen a "surge in the number of client queries relating to estate planning" since the chancellor's Autumn Budget announcement, while RBC Brewin Dolphin reports that it has seen an increase in the number of people seeking to withdraw more money from their retirement funds.
According to RBC Brewin Dolphin, it is getting inquiries from customers who want to take out more "taxable income" from their retirement accounts. This often brings them up to the higher rate threshold of 42,663 in Scotland and 50,271 in England, Wales, and Northern Ireland.
In severe circumstances, savers are choosing to withdraw funds from their pensions up to the additional-tax rate threshold of 125,140, pay 40% tax on income over £50,271, and give sizable gifts to family members.
The wealth manager says that by taking this action, they hope to start the seven-year countdown to inheritance tax exemption, which will allow the money to grow with the new owners without worrying about an IHT liability.
In the end, many people would prefer to pay 20 percent or 21 percent in income tax in Scotland rather than 40 percent inheritance tax when they die, says Daniel Hough, wealth manager at RBC Brewin Dolphin. But having a comfortable retirement and transferring wealth as effectively as possible are two different things.
Claire Trott, head of the advice department at St. In James' Place, there is a risk that individuals will incur income tax bills that surpass the inheritance tax they are attempting to evade.
Consider a 45 percent income tax now and a 40 percent inheritance tax later. The tax-free growth inside the pension wrapper is also lost. A person who makes large withdrawals may enter the 60 percent effective tax band or forfeit other important benefits associated with adjusted net income, she tells the BFIA.
5 billion taxable payments were withdrawn flexibly from pensions by 672,000 savers in the first three months of 2025, according to recent data from HMRC. This represents a 24% increase in the value of the payments withdrawn compared to the same quarter in 2024, as well as a 13% increase in the number of people withdrawing.
RBC Brewin Dolphin conducted a survey of wealthy retirees earlier this year, and the results showed that 56% of them intended to increase their pension spending after the government decided to include them in estates for IHT.
Retirees who increase their withdrawals from their nest eggs run the risk of running out of money in addition to being hit with higher income tax and possibly higher income tax rates if they move up a tax band.
Hough advises pension savers who are tempted to make significant adjustments to their retirement plans in an attempt to evade inheritance tax to carefully consider how long their pension fund will last. If your pension runs out in your 80s or 90s, you might have to live with the consequences, or you might need to scale back your goals," she continued.
The life expectancy for a woman aged 66 is 88 years on average. Nonetheless, she has a one in four chance of surviving to be ninety-four and a one in ten chance of becoming 98. The average life expectancy for a man who is 66 years old is 85.
"It may seem tempting to take out more money from your pension pot," says Richard Cook, senior financial planner at Rathbones. However, taking out more money could put you in a higher income tax bracket, which means that more of your hard-earned money might wind up in the hands of the tax collector rather than in your pocket.
Additionally, taking too much out of your pension too soon can cause it to run out faster than expected, leaving you vulnerable later in life when you might need the money the most.
The dangers of raising your rate of pension withdrawal.
According to figures from the trade association Pensions UK, the average single person requires 43,100 annually after taxes to fund a "comfortable" retirement, while the average couple requires 59,000 annually after taxes. All of your necessities would be met, along with a few extras like a two-week getaway in a four-star Mediterranean resort and a car replacement every five years.
According to RBC Brewin Dolphins' analysis, if a person with a 500,000 pension retired at age 66 and began taking out 43,100 in net income annually (50,887 before taxes), their pot might run out by the time they were 77. This does not account for the state pension and assumes that the fund grows at a rate of 5% annually after fees and that income rises at a rate of 2% annually with inflation. The pension could last until the age of 84, starting with a 750,000 pension.
Because the full new state pension would increase their income by approximately 11,973 per year, they might be able to take out less money from their personal pensions. A 500,000 pension, for instance, could last them an additional four years until they were 81 if they began taking out net income of 31,127 annually (38,914 before taxes). They could still have money in their pot at age 93 if they received a 750,000 pension.
All of this is contingent upon the pension portfolio generating a 5% annual return. If not, the pension fund may deplete more quickly. Additionally, your pension pot's longevity will decrease even more quickly if more money is taken out, such as to try to avoid the tax collector taking a 40% cut on any pension that remains after your death.
The 4 percent pension rule is used by some retirees to determine a safe withdrawal amount. This rule states that you should take out 4 percent of your pension pot in the first year and increase it by inflation each year after that. Your pension pot should last for at least 30 years.
There might be negative effects if this is raised, say by 5%. "Ask a financial advisor about the potential long-term impact on your retirement plans if you're thinking about taking large additional withdrawals from your pension pot," advises Hough.
Over a period of 20 or 30 years, even a single percentage point can have a significant impact, possibly leaving you short when you most need financial support.
Strategies for controlling the inheritance tax that is applied to your pension.
Pensions will be impacted by the inheritance tax (IHT) grab starting in April 2027, but there are strategies to handle it.
Giving a family gift.
Giving loved ones presents now can take money out of your estate and lessen the likelihood that they will receive an IHT bill after you pass away.
"Good IHT planning often starts with knowing what you can afford to give away," says Cook at Rathbones, to prevent income tax shocks or running out of money in retirement.
To determine what capital and income you can contribute, create a cash flow plan or a thorough budget. This can be aided by a financial advisor.
Trott at St. According to Jamess Place, "Giving money away is a one-way street; once it's gone, it's gone. Therefore, careful planning is essential to comprehend all the consequences."
The inheritance tax gifting rules allow civil partners and spouses to give each other an unlimited amount of assets. However, each person is entitled to a gifting allowance of 3,000 per year, free of IHT, in order to pass wealth on to the following generation. This exemption may be carried forward for one tax year if all or a portion of it is not used in a given tax year.
Hough continues: "There are other one-time exemptions to take into account, like gifts of up to £1,000 per person for a wedding or civil ceremony, which rise to £2,500 for gifts to a grandchild or £5,000 for a child. Make sure to document any family members you give these to.
Money that exceeds these allowances is free from IHT seven years after it is given. If you pass away sooner, your IHT rate will be lower on a sliding scale. For instance, 24 percent IHT is due if you pass away four and a half years after giving money to a loved one.
It should be noted that there are rumors that in the upcoming Autumn Budget, Chancellor Rachel Reeves may alter the seven-year rule on gifts or impose a lifetime cap on the amount of wealth that can be distributed free of IHT. Thus, watch for any tax-related announcements later this year.
Utilize trusts.
A legal arrangement for the management of a group of assets on behalf of individuals is called a trust. There were 733,000 registered as of March 31, 2024, according to HMRC. In general, there are two primary categories of trusts: absolute and discretionary.
Whereas discretionary trusts introduce various classes of beneficiaries rather than naming specific individuals, absolute trusts give trustees the authority to determine how the assets are distributed to beneficiaries as income, lump sums, or when they reach a specific age.
Hough remarks: "Trusts might be a good choice for people who wish to keep some control. The individual can designate beneficiaries under these arrangements, and they can choose to distribute the money through capital growth or income.
"The assets in a trust won't be lost during the bankruptcy or divorce procedures, making them extremely effective tools in the event that the next generation experiences financial difficulties or separates from their partners. However, the cost of setting up, maintaining, and relaxing can be high.
Purchase insurance.
Another option is to purchase a life insurance policy. For estates with illiquid assets that might be hard to sell in just six months, you can purchase protection for a sum that would cover a future liability, even though it doesn't always lower or eliminate a potential IHT bill. Consider the following three life insurance policy types: whole life, gift inter vivos, and term.
Hough clarifies: "You can set up protection to cover it if your partner has already passed away and you know what your loved ones' likely IHT liability is. While the IHT bill will still exist, the policy's lump sum payout will cover the liability, making it a practical choice if you want to save money for retirement or care expenses.
For instance, you can purchase life insurance to cover the £250,000 left over after passing down your estate if you estimate that this amount will be necessary. Bypassing the deceased's estate, the money received if and when this pays out can be placed into a trust with designated beneficiaries.
Important considerations should be made for every kind of policy. You are only covered by a term policy for a predetermined period of time, such as ten or twenty years. Due to stringent underwriting and a significant reliance on age and health, whole life insurance will almost always be the most costly. Hough adds, "Gift Inter Vivos policies are typically the least expensive choice, but they only offer seven years of coverage.
Verify that the life insurance policy is written in trust. In 2022 - 2023, HMRC reports that nearly 7,500 families paid inheritance tax on life insurance policies; however, many would have avoided a bill if their policy had been written into trust.
Think about donating extra money with an annuity.
There is no cap on the amount that can be donated under the IHT gifting rules, and the seven-year clock is not applicable.
You could turn a pension fund that you don't need into an annuity and distribute the payouts as "surplus income" if you have enough money coming in from other sources to maintain your typical standard of living.
Cook remarks: "If you have extra money from an annuity, you might be able to give it to your loved ones on a regular basis. As long as it stays outside of your estate for IHT purposes, that is.
The seven-year rule might apply to your gifting, though, unless your income is genuinely excess to your needs and is properly documented.
Trott concurs, saying: "Annuities are becoming more popular, especially in cases where extra money can be given as a gift or used to pay for a life insurance policy to leave a legacy for cherished ones.
"They can contribute if done properly, but there is a chance that increasing the estate will exacerbate the IHT issue. It all comes down to carefully structuring them.
In a separate article, we examine whether this is a good time to purchase an annuity.
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