‘Should I splurge my pension at 60 to dodge inheritance tax?'

Telegraph

04-03-2025

Write to Pensions Doctor with your pension problem: [e-mail]. Columns are published weekly.
Dear Charlene,
The principal reason for making contact was to seek your thoughts on how the inheritance tax changes announced last October have changed views regarding the timing of drawing of pensions.
The commonly accepted wisdom previously was that one should draw on pensions once other savings has been exhausted due to the inheritance tax exemption. I appreciate there were other considerations to consider (such as reaching age 75), tax position and family circumstances.
Does this 'draw last' mantra fall away post the introduction of the tax changes? Or does the tax wrapper of Sipps still encourage individuals to draw on their savings last? In the event there was a choice to draw on Isas vs Sipps, should the former still be drawn first?
On a separate point, I have a defined benefit pension scheme. I am turning 60 next year, which would be the normal retirement age for the scheme. Do the changes in inheritance tax alter the approach to drawing on the pension and whether someone should delay taking it?
Many thanks,
– Chris
Dear Chris,
The proposed changes to pensions and inheritance tax are not yet finalised. The consultation on how the initial proposals might work closed in January, and the Government received significant feedback and concerns.
One thing is clear though – the Government wants to encourage people to use their pensions in retirement, rather than leaving them untouched as a way of passing on wealth free of inheritance tax.
While it's difficult to second guess how the changes might work, they've certainly got people thinking about the order in which they might want to access their retirement savings.
At this point in time, there isn't enough information to give you a precise answer, so I've set out the general situation and my thoughts.
Inheritance tax considerations
Even with the proposed changes, most people will not leave estates with an inheritance tax liability.
Married couples will usually have up to £1m that can be sheltered from the tax between them, thanks to spousal exemptions and the combined effects of the nil-rate bands on offer.
Inheritance tax usually applies at 40pc on assets above available allowance and exemptions. The nil-rate band is £325,000 per person, with up to £175,000 available as an additional residence nil-rate band for people who leave their property to a direct descendant. This starts to get tapered away for the highest-value estates (more than £2m).
If you have a spouse or civil partner, they'll also inherit an additional Isa allowance, called the 'additional permitted subscription'. This means you can pass on not just the total wealth in your Isas to them, but the value of the tax-free wrapper too.
Accessing your pensions
You can usually take up to 25pc of the value of your pension(s) tax-free (subject to the overall lump sum allowance of £268,275), with withdrawals above this subject to income tax at your marginal rate.
Defined contribution schemes let you buy an annuity with the remaining pension pot to give you a secure, guaranteed income for life or leave funds invested to drawdown which you can withdraw from as and when you need to.
Alternatively, you can access chunks of you pension at a time, with 25pc tax-free and the remaining 75pc taxable.
Your defined benefit pension will pay you an income based on your salary and your length of service. You'll also be able to up to 25pc tax-free, although it varies between schemes as to how this affects the starting pension income you receive.
It'll be up to your scheme whether you can defer taking this pension. If they allow it, you'll need to understand if they pay you arrears or whether you'll benefit from a higher pension when it does start, but you'll need to work out whether this extra money will make up for the years you won't be getting the income for and to factor in the tax consequences.
From an inheritance tax point of view, this scheme has no 'pot', so there is little benefit in not taking it. The main consideration will be your other income and the rate of income tax you'll pay.
It will also usually pay a pension to your spouse or dependant if you die. This would not form part of your estate under the pensions and inheritance tax proposals in the same way as an unused pension pot.
It's also worth keeping in mind that you'll be able to claim any state pension from age 66 which, although paid gross, also counts towards your total income for tax purposes.
Spending in retirement
As you've mentioned, what to do with any income from your pensions and other accounts really does depend on your personal situation, what you'd like from retirement, and making sure you don't leave yourself short in funding that first.
Under the inheritance tax proposals, it will make sense for most people to take their tax-free cash from their pension pots before they turn 75.
Plenty of people already do that, and often have plans for all or some of the money. What they don't spend stays within their estate when working out inheritance tax – just like it would in an unused pension pot under the inheritance tax proposals.
But if the money was kept within the pension, the beneficiary will (also) pay income tax when they take it out, if the original pension holder dies after reaching age 75. This potential double taxation is a big area of concern with the current proposals.
Rather than exhausting one type of account before the other, a blended approach (between pensions, Isas and any other investments) will help you make the most of the tax allowances on offer through your retirement, and perhaps mean you can help your loved ones, too.
As all Isa withdrawals will be tax-free, on the face of it, using Isas to supplement your income after taking tax-free cash seems like the obvious place to start to keep more of your withdrawals.
But if you are worried about inheritance tax, then taking income from your pension(s) too could help you to reduce the value of your estate, help you spend more on yourself to get the most from retirement, and even make gifts to loved ones. Remember that taking pension income withdrawals (above your tax-free cash) could mean you tip into a higher income tax bracket.
Some people are considering giving away their taxed pension income as gifts to help their children make extra pension contributions. Not only does the child's retirement pot get a boost, but they'll also get tax relief on the money paid in, which could in some cases cancel out (or even be worth more than) the income tax you paid on the way out.
Making gifts and inheritance tax rules can be complex though, so it's an area I would suggest you get some professional advice on to avoid any costly mistakes.
What you can do now
While we wait for the new rules, there are a couple of things you can do.
The first is to review your pension nominations. Nominating a pension beneficiary gives them the option to move anything they inherit from you into their own pensions, rather than being left with a lump sum option.
It's also worth reviewing your will and considering setting up a power of attorney.
If you're still unsure of the best path when we get more information on the proposals, I'd really recommend getting some qualified financial advice to put your mind at rest.
Best wishes,
– Charlene
Charlene Young is a pensions and savings expert at online investment platform AJ Bell. Her columns should not be taken as advice or as a personal recommendation, but as a starting point for readers to undertake their own further research.