Should I draw down my pension before 2027?

The April 2027 pension inheritance tax changes have prompted a lot of questions. This is the one most people are really asking.

It is a completely understandable reaction. For years, leaving unused pension funds intact was one of the most tax-efficient financial decisions you could make. The new rules change that calculation. But the answer to whether you should draw down before 2027 is not straightforward, and for many people, rushing to empty their pension pot could actually make things worse.

This article explains what the changes mean, who they affect most, and how to think through the draw down question clearly before making any decisions.

What changes in April 2027 and why it matters

Under the current rules, most unused pension funds sit outside your estate for inheritance tax purposes. When you die, the remaining money in your pension pot can be passed to your beneficiaries, and if you die before age 75, those funds are often inherited free of income tax too.

From 6 April 2027, most unused pension funds from defined contribution pensions will be included in the value of your estate for inheritance tax purposes. If your total estate, including your pension, exceeds the available nil rate band thresholds, the amount above the threshold will be subject to inheritance tax at 40%.

The income tax treatment is also changing. Beneficiaries who inherit pension funds from someone who died after age 75 will pay income tax on withdrawals at their marginal rate. In some cases, the combination of inheritance tax and income tax on the same pension money could result in a significant portion being lost to tax.

Two important caveats before going further. Tax treatment depends on individual circumstances and may change over time. And the detail of the April 2027 rules is still emerging, so this article will be reviewed and updated as HMRC publishes final guidance.

Who is most affected by the pension inheritance tax changes?

The April 2027 changes will affect some people significantly and others hardly at all. The people most likely to be affected are those who have deliberately preserved their pension pot as a tax-free legacy vehicle, drawing down other assets first while leaving pension savings largely untouched.

If your total estate, including your pension, is below the nil rate band thresholds, the changes may have little practical impact. If your estate is already above the thresholds without the pension, adding the pension value will increase your inheritance tax liability further.

Those with large defined contribution pension pots accumulated over a long working life, who were planning to leave most of it to their adult children or grandchildren, will feel the biggest change. Under the new rules, passing pension money to children and grandchildren will incur inheritance tax at up to 40%, where previously it could pass free of inheritance tax entirely.

What remains exempt from inheritance tax after April 2027?

Not everything changes. Pension funds passed to a surviving spouse or civil partner remain exempt from inheritance tax, as they do now. The inheritance tax charge is effectively deferred until the survivor’s death, when the combined estate is assessed. Funds passed to registered charities also remain exempt.

Death in service benefits paid as a lump sum through an employer scheme are also expected to remain outside the estate in most cases, though you should confirm the treatment of your specific scheme with an adviser.

So should I draw down my pension before 2027?

This is where the answer gets personal. For some people, drawing down more pension income before April 2027 makes genuine sense. For others, it could increase their tax bill rather than reduce it. The right answer depends on your individual circumstances.

The case for drawing down more before 2027

If your estate is likely to exceed the inheritance tax thresholds and you have a large unused pension pot, drawing down more before 2027 allows you to take the money as pension income now, pay income tax at your marginal rate, and then use the after-tax cash in ways that may be more inheritance tax efficient.

Pension income up to your personal allowance is tax free. If your total income in retirement is below the personal allowance, you could draw pension money at an effective rate of 0%. Even above the personal allowance, paying 20% income tax on pension withdrawals now may be preferable to your beneficiaries facing 40% inheritance tax on the same money later.

Drawing down also gives you the option to make lifetime gifts, use your annual gift exemption, or move money into ISAs, where investments remain free of income tax and capital gains tax during your lifetime and do not face the same inheritance tax treatment.

The case against drawing down before 2027

Drawing down your pension more quickly than you planned is not automatically the right financial decision, even with the rule changes coming.

If drawing additional pension income pushes you into a higher income tax bracket, you could end up paying 40% or even 45% income tax on money you withdraw now. That is the same effective rate as the inheritance tax your family might eventually pay, so there is no saving.

Your pension savings can also continue to grow free of income tax and capital gains tax for as long as they remain invested inside the pension, which compounds over time. Taking money out and moving it elsewhere loses that benefit. The usual caution applies: investment values rise and fall, growth is never guaranteed, and you could get back less than you invest.

There is also the simple question of whether you actually need the money. Drawing down more than you need for retirement income just to avoid a future inheritance tax charge may not serve your own financial security.

What practical steps are worth taking before April 2027?

Whether or not drawing down early is right for you, there are several practical steps that are worth taking now.

Review your pension nominations

Pension funds pass according to your nominated beneficiaries, not your will. Under the new rules, passing pension money directly to a surviving spouse or civil partner remains exempt from inheritance tax. Passing it directly to adult children will not be.

Many people who previously nominated their children or grandchildren as direct beneficiaries may want to reconsider whether nominating a surviving spouse or civil partner first, to defer the inheritance tax charge, better reflects their wishes under the new rules. Review your nominations and update your letter of wishes with your pension provider.

Understand your taxable estate including the pension

The starting point for any planning is knowing your actual position. Add up the net value of your estate, including your property, savings, other assets, and your unused pension funds, and compare it against your available nil rate band and residence nil rate band. That tells you whether the April 2027 change creates a material inheritance tax liability for your family or whether it has little practical impact.

Consider the order in which you draw down your assets

For people who have ISAs, savings, and a pension, the order in which you draw down different assets in retirement now matters more than it did. Drawing on ISAs and savings first while leaving the pension intact was previously the most tax-efficient approach for passing wealth to the next generation. From April 2027, that calculation changes for many people and the optimal order depends on your individual tax position.

Think about the 25% tax free cash

Up to 25% of your pension pot, subject to a maximum of £268,275 under the current lump sum allowance rules, can be taken as a tax free lump sum. If you have not yet taken your tax free cash and your pension is likely to be subject to inheritance tax, taking it before April 2027 and moving it into a more tax efficient structure may be worth considering as part of a wider plan. Remember that the value of any tax benefit depends on your personal position and the rules in force at the time.

The right answer depends on your numbers, not the headlines

The April 2027 pension inheritance tax changes are significant. But whether you should draw down your pension before they arrive is a question that only makes sense with your full financial picture in front of you.

The income tax you pay now, the inheritance tax your family faces later, your retirement income needs, and your estate as a whole all need to be weighed together. A short conversation with a financial adviser gives you a clear answer based on your actual circumstances, not a general rule that may not apply to you.

Book a no-obligation chat with one of our advisers today. The sooner you understand your position, the more options you have before the rules change.