What You Need to Know
- From April 2027, unused pension savings count as part of your estate for inheritance tax - at 40% on anything above your nil-rate band.
- The old rule of drawing ISAs first and keeping your pension untouched is no longer the default. For many people, drawing pension income earlier now makes more sense - both for income tax and inheritance tax reasons.
- The years between stopping work and your State Pension starting are a useful window: pension withdrawals up to your Personal Allowance (£12,570) cost you nothing in income tax and reduce your IHT-exposed balance.
- Age 75 is a key milestone - death benefits become taxable as income for beneficiaries after this point, on top of any inheritance tax.
- Your pension nominations, your will, and your drawdown strategy now need to work together. If you have not reviewed all three recently, it is worth doing so.
Your Pension Is No Longer IHT-Free - and That Changes Everything
For decades, the advice was simple. Keep your pension untouched for as long as possible. Draw your ISAs and other savings first, leave the pension for your beneficiaries, and the fund passes outside your estate free of inheritance tax. It was one of the clearest, most consistent rules in UK financial planning.
That rule no longer applies.
From April 2027, most unused defined contribution (DC) pension funds will be included in your estate when you die, subject to inheritance tax at 40% on everything above your available allowances. It is the most significant change to pension planning since the pension freedoms of 2015 - and it reverses conventional wisdom that shaped how millions of people structured their retirement income.
This article explains what changes, what it means in practice, and what is worth reviewing in your own plan.
How the Old Rules Worked - and Why They Are Changing
Under the rules that applied before April 2027, unspent pension savings sat entirely outside your estate. A £400,000 pension fund left untouched could pass to your children or grandchildren without a penny of inheritance tax. This made the pension the most IHT-efficient asset most people could hold.
The strategy that followed from this was logical: spend your ISAs and other accessible savings first, draw from your pension only when necessary, and preserve the remaining fund as a tax-free legacy.
From April 2027, unused pension pots - both untouched funds and drawdown funds still held inside the pension wrapper - form part of your estate for inheritance tax purposes. The nil-rate band (currently £325,000 per person, frozen until 2031) applies across your whole estate, and the 40% rate applies to the taxable portion above it.
For people with meaningful pension savings and estates already approaching those thresholds, the pension is no longer the inheritance-tax shelter it used to be.
The Shift in Strategy: When Drawing Your Pension Earlier Makes Sense
The most important practical change is in the order you draw your income. Under the old rules, drawing pension income early was mainly an income tax decision. Now it is an inheritance tax decision too - and in many cases the two point in the same direction.
Here is the core logic.
In the years between stopping work and your State Pension starting, your Personal Allowance (currently £12,570 a year) is largely unused. Drawing pension income up to that allowance costs you nothing in income tax - and at the same time reduces the pension balance that would otherwise sit in your estate.
Once your State Pension begins (currently worth around £12,547 a year), it absorbs most of your Personal Allowance. From that point, further pension withdrawals are more likely to attract income tax at 20% or higher. The window before State Pension age is therefore a useful opportunity to extract value from your pension at low or zero tax cost - and shrink a pot that would otherwise face inheritance tax on death.
Your ISA savings, which you might previously have drawn first, can now be kept in reserve. ISA withdrawals remain free of income tax for the person drawing them, and preserving them for later years can help keep your total income below the higher-rate threshold.
This is a meaningful reversal of the ISA-first approach - and it is one of the most practically significant shifts in pension planning for anyone with both pension savings and ISA savings to consider.
One important note: triggering flexible drawdown reduces your future pension contribution allowance from £60,000 to £10,000 a year. If there is any chance you may return to work and want to continue contributing, this is worth factoring in before activating drawdown.
Other Areas Worth Reviewing
The April 2027 changes reach further than just the income sequencing question. A few other areas are worth understanding as you think about your own plan.
The age-75 milestone. Before age 75, most pension death benefits pass to beneficiaries free of income tax. After 75, those same benefits become taxable income for whoever receives them - on top of any inheritance tax. This makes the years approaching 75 an important window for reviewing how your pension is structured and who your nominated beneficiaries are.
Your pension nominations. Nominations are not legally binding - trustees retain discretion - but they are highly influential. With the new rules, who you nominate and in what proportion now has direct inheritance tax implications. Reviewing nominations alongside your will is straightforward and often overlooked.
Gifting regular pension income. If you draw regular pension income and do not need all of it to live on, UK inheritance tax law includes an exemption that allows you to gift the surplus regularly, immediately outside your estate. Known as the normal expenditure out of income exemption, it requires a documented, habitual pattern of gifts made from income rather than capital. It is worth understanding if this kind of regular gifting could be part of your plan.
The Residence Nil Rate Band taper. If your total estate - now including your unused pension - pushes above £2 million, you begin to lose the Residence Nil Rate Band, which is an additional allowance of up to £175,000 per person. It tapers away entirely at £2.35 million. For estates in this range, the pension inclusion can have a compounding effect on the overall tax bill.
Explore With the RetirePlan App
None of the above is personal financial advice. Pension planning is complex, and the right approach depends on your full financial picture. If you are making significant decisions about how you draw your pension or structure your estate, speaking with a regulated financial adviser is the right step.
What RetirePlan can do is help you understand your numbers and the sequencing logic. The Finance Planner walks you through how your different income sources are drawn down automatically - and gives you two practical adjustments to try: you can increase ISA savings in years where your other savings are sufficient, and you can change your pension drawdown rate in the pension module. Those two levers cover the most important decisions most people face under the new rules. It is a useful starting point before any adviser conversation.
Ready to see how your plan looks? Download the free RetirePlan app on the app stores or web - your first projection takes less than 10 minutes.
