From 6 April 2027, the inheritance tax treatment of many unused pension funds and death benefits is due to change.
This has understandably led some pension holders to ask a seemingly simple question:
Should I take my 25% tax-free lump sum before April 2027?
For some people, accessing pension money may form part of a sensible wider strategy. For others, taking money out simply because the inheritance tax rules are changing could create a different problem.
The important point is that taking the tax-free cash does not automatically reduce inheritance tax.
What Is the 25% Tax-Free Pension Lump Sum?
Most people with defined contribution pensions can currently take up to 25% of their pension benefits tax-free, subject to the applicable lump sum allowance and their individual circumstances.
For example, someone with a £1 million pension might potentially be able to access £250,000 tax-free, assuming they have sufficient available allowance.
But tax-free when withdrawn does not mean inheritance-tax-free once it is sitting in your bank account.
That distinction matters.
What Changes From April 2027?
The Government has announced that, from 6 April 2027, most unused pension funds and pension death benefits will be brought within the scope of inheritance tax.
Historically, pensions have often been treated differently from many other assets for inheritance tax purposes.
That has made pensions an important consideration when deciding which assets to spend during retirement and which assets to preserve.
The April 2027 changes mean that many families will need to reconsider that assumption.
Does Taking the 25% Tax-Free Cash Solve the Problem?
Not necessarily.
Imagine you have a £1 million pension and withdraw £250,000.
If that £250,000 simply moves from your pension into your bank account or investments held personally, it will generally form part of your estate for inheritance tax purposes.
You have changed where the money is held, but you may not have reduced the value of your taxable estate.
This is why withdrawing pension money purely because the rules are changing can be misleading.
The important question is:
What happens to the money after you withdraw it?
What If You Spend the Money?
This can produce a very different outcome.
If pension withdrawals are genuinely used to fund your lifestyle — holidays, home improvements, family experiences or other expenditure — the value of your estate may reduce over time.
But that decision needs to be considered alongside your future income requirements.
Reducing inheritance tax at the expense of your own financial security is unlikely to represent good estate planning.
What If You Give the Money to Your Children?
Another possibility is gifting some of the withdrawn money.
However, withdrawing £250,000 and immediately giving it to your children does not necessarily make the inheritance tax issue disappear.
Depending on the circumstances, a gift to an individual may be treated as a Potentially Exempt Transfer.
The seven-year rule can therefore become relevant.
There may also be exemptions available for certain gifts, including qualifying regular gifts made from surplus income.
The tax treatment depends on what you do, how you do it and your individual circumstances.
What If You Leave the Money Inside the Pension?
Leaving the money invested inside the pension may still have advantages.
Pensions can provide:
- tax-efficient investment growth,
- flexibility over retirement income,
- potential protection from unnecessary spending,
- and an important source of income later in life.
Inheritance tax is therefore only one factor in deciding what to do with a pension.
Making a pension decision purely to solve an inheritance tax problem can potentially create income tax, investment or retirement-planning consequences elsewhere.
Your Wider Estate Matters
Consider two people who each have a £1 million pension.
One owns a £400,000 home and has relatively few assets outside the pension.
The other owns a £1.5 million home and has £1 million of investments outside the pension.
They may have exactly the same pension, but the inheritance tax implications and planning priorities could be very different.
This is why the pension should not be considered in isolation.
Property, investments, cash, income requirements, beneficiaries, life expectancy and existing estate planning all matter.
Don’t Wait Until April 2027 to Review It
The new rules are scheduled to apply from 6 April 2027.
That does not mean everyone should rush to withdraw pension money.
But it does mean people with significant defined contribution pensions should understand their position before the changes take effect.
The objective is not to take action for the sake of taking action.
It is to know what your estate could look like under the new rules and whether there are legitimate planning options worth considering.
Could the April 2027 Pension Changes Affect Your Estate?
If your pension represents a significant part of your wealth, the April 2027 inheritance tax changes could alter how it fits into your wider estate plan.
Estate Architect can help you understand your current inheritance tax exposure, how your pension interacts with your other assets and which areas may deserve closer attention before the new rules take effect.