Should you withdraw your pension before inheritance tax rule changes? What you must consider first

After years of being told to spend our pensions last because they could be handed down free of inheritance tax, a new rule coming in from next April flips that guidance on its head. From 6 April, 2027, most unspent pensions passed on will be included in the estate for inheritance tax (IHT) purposes and could be taxed at 40%.

The move has triggered a big change in behaviour, with many over-55s (the earliest you can currently take your pension) withdrawing more of their money sooner rather than later, often to help out younger generations. Experts are cautioning about knee-jerk financial decisions, however.

Michelle Holgate, director and wealth manager at RBC Brewin Dolphin, said: “The inclusion of pensions in estate calculations for inheritance tax purposes from April 2027 is already reshaping how clients and advisers are approaching planning conversations.

“For some retirees, the instinct to act quickly by drawing down a pension and gifting the proceeds to children is understandable, but there are a number of important considerations.”

Record pension withdrawals

In the 2025/26 tax year, £22.4 billion in taxable payments was withdrawn from pensions flexibly – marking a new record, according to HMRC. This has increased by £3.8 billion in the previous financial year (2024/25). It is also up by £7.1 billion since 2023/24.

Much of this money is being given away to younger generations as gifts during their parents or grandparents’ lifetime. More than half of first-time buyers received financial help from family in 2025, for example, amounting to a total of £8.3 billion, according to research by estate agency Savills.

At the same time, just over two thirds (67%) of parents and grandparents already funding private school or university costs say the inheritance tax change is motivating them to provide further financial support during their lifetime, a separate survey of 1,010 people in May 2026 by Rathbones found.

“More clients are choosing to help children and grandchildren now – whether that’s supporting housing, education or other financial needs – rather than waiting for assets to pass on death,” said Ross Coombes, senior financial planning director at Rathbones.

“For many, the ability to see the impact of that support during their lifetime is a key motivation, alongside the tax considerations.”

Gifting – things to consider

1. Care costs

Before taking any action, experts said it is important to be realistic about your retirement needs and health so you can plan around how much money you are likely to need during your lifetime.

Giving away lump sums may cause issues further down the line if you need to rely on local authority support to meet care costs. The rules on ‘deliberate deprivation of capital’ may mean that the local authority may seek to recover their extra costs from you or those you have made the gift to.

Nick Clark, chartered financial planner at Lubbock Fine Wealth Management, said: “If you make large gifts or spend your tax-free lump sum too quickly, you cannot get that money back later in your retirement when you might need it most – and you may face undue tax liabilities during your lifetime.”

2. Income tax

Pulling large amounts from your pension to avoid your loved ones paying an IHT bill tomorrow could leave you with a big income tax bill today.

“While up to 25% of any withdrawal may be tax-free, the balance is added to your other income in that tax year. For some this may mean they pay 40% (or 45%) on some or all the taxable amounts [of the pension withdrawal],” said Sean McCann, chartered financial planner at NFU Mutual.

Becoming a 40% (or 45%) taxpayer has other knock-on consequences, such as a reduction in the tax-free savings allowance of £1,000 to £500 if you become a 40% taxpayer and complete loss if you move into the 45% band, he added.

Some of the other consequences of moving up a tax band include paying a higher tax rate on dividend income (if you have used your £500 a year dividend allowance) and the loss of the marriage allowance (if your spouse or civil partner claimed it) if you’re no longer a basic rate taxpayer.

If the taxable pension lump sum together with your other income means you breach £100,000 of taxable income per year, you begin to lose the tax-free personal allowance. “In which case, anything between £100,000 and £125,140 is effectively taxed at 60%’’, McCann said. This is known as the 60% tax trap.

Taking more than the 25% tax-free allowance will also trigger the Money Purchase Annual Allowance, restricting future gross annual contributions to a maximum of £10,000.

3. Inheritance tax

Inheritance tax is one of the most feared but least understood taxes. The rules can be tricky to navigate so it may be worth speaking to a professional financial adviser, but there are some key things to remember.

First up is the seven year rule. ‘’Lump sum gifts remain in the estate for seven years – they effectively ‘eat’ the £325,000 tax-free allowance first. The reduction if you die between years three and seven only applies if more than £325,000 gifted’’, said McCann. In some cases, earlier gifts also need to be reviewed. Ensuring the history of gift making is properly analysed is essential and easily overlooked.

Gifts from regular income, which don’t impact normal standard of living, are free of IHT immediately. McCann said many people are buying annuities and giving away excess income, “in the knowledge they can stop the regular gifts if their circumstances change’’. Keeping good records of the gifts are essential, though.

You can also give away up to £3,000 each tax year and carry forward any unused allowance for one year, via the annual exemption. Used consistently it can make a meaningful difference, provided clear records are kept, Tony Cockayne in the disputed wills and estates team at law firm Michelmores says.

Marriage and civil partnership gifts can be exempt, but only within set limits: £5,000 from each parent, £2,500 from each grandparent or great-grandparent, £2,500 between the couple, and £1,000 from anyone else.

The gift must be made before the ceremony and conditional on it taking place, so leaving it until afterwards risks losing the exemption, Cockayne warns.