27-05-2025
Should I empty my pension into an Isa to dodge the looming 'double tax' on inheritance?
I am worried the size of my pensions will make my children liable for inheritance tax after the changes from 2027.
I'm over 55, so is it a sensible idea to start making pension withdrawals, while keeping my annual income under the higher rate income tax threshold, and over time decant these funds into a stocks and shares Isa instead.
The idea would be to empty my pensions entirely into my Isa by the time I reach state pension age.
One of my reasons for doing this is that if I died after the age of 75 with some of my pension pot left, my children could face double taxation under the proposed new system, with inheritance tax on the pot and then income tax on their withdrawals.
I realise any money left behind in Isas is liable for inheritance tax too, but the investments can grow in a tax efficient way like in a pension. At least I could access and spend the money freely without worrying about income tax, and maybe not inheritance tax in the end either.
What would be the pros and cons of this strategy?
Tanya Jefferies, of This is Money, replies: Many savers with larger pensions are keen to avoid a new inheritance tax levy.
The money remaining in pension pots is going to become liable for death duties like other assets, such as property, savings and investments starting in April 2027.
Some wealthy families will face a 'double tax hit' on inherited pensions.
If a saver is aged over 75 when they die, their beneficiaries are still going to have to pay their normal income tax rate of 20 per cent, 40 per cent or 45 per cent on pension withdrawals too.
For a 45 per cent taxpayer this represents a 67 per cent tax rate, and the tapering of the residence nil rate band down to nothing on estates worth £2million-plus would mean an effective tax rate of 70.5 per cent.
It's no surprise then that people are casting around for ways to cut or eliminate a heavy future tax bill for their family.
Before you even start worrying about this though, you should first consider if you really are likely to have a big enough estate to pay inheritance tax, especially after you have spent down your pensions during retirement.
Scroll down to check the rules on who pays inheritance tax.
Among those who will be affected, some are looking to cash in as much of their pensions as possible, while avoiding a big income tax bill - although it is better to avoid crystallising losses by making bigger pension withdrawals in market downturns.
Recent research showed many savers with larger pensions intend to spend them by splashing out on more holidays.
Other options include gifting out of surplus income which remains inheritance tax-free providing you can afford it, or buying life insurance and putting it in trust.
Some savers will be deciding whether to leave more or all of their estate to spouses, who can still benefit from estates free of inheritance tax, instead of their children to delay and minimise the eventual bill.
Wealth manager Evelyn Partners has suggested we could see a marriage boom or rise in civil partnerships among older couples as a result, and it has suggested six ways to cut inheritance tax on pensions here.
Meanwhile, some people have raised the idea of siphoning pension funds into an stocks and shares Isa - even though these are also liable for inheritance tax, and there are other pitfalls.
Several commenters on this recent story about families falling into the pension inheritance tax trap said they had started doing this already.
We asked an experienced financial adviser to give his take on this strategy below.
Ian Cook, chartered financial planner at Quilter Cheviot, replies: While it might seem intuitive to start drawing down a pension to move funds into a stocks and shares Isa in anticipation of inheritance tax changes, this approach comes with significant trade-offs that need careful consideration.
From 2027, the government plans to bring pensions fully into the scope of inheritance tax.
This has prompted concern among individuals with sizeable pension pots who are understandably looking for ways to mitigate a potential future tax bill for their beneficiaries.
However, emptying a pension now in favour of an Isa could backfire.
Firstly, withdrawing pension funds incurs income tax, and if you're still working or exceed your personal allowance, you could pay 20 per cent or more on each withdrawal.
For example, to invest £20,000 into an Isa, you'd need to make a gross withdrawal of £25,000, instantly losing £5,000 to income tax.
If those funds are then liable for 40 per cent inheritance tax later, you've effectively turned £50,000 in your pension into just £30,000 in net Isa capital.
Isas, while tax-free in terms of income and gains, are fully liable for inheritance tax.
Pensions while set to lose their favourable inheritance benefits still retain certain advantages, such as the ability to make gifts out of surplus income.
There's also the matter of future reform. Isa rules are currently under review and there is no guarantee that today's generous allowances or freedoms will remain.
Once you begin taking taxable income from your pension, you also trigger the Money Purchase Annual Allowance, reducing the amount you can contribute to pensions each year from £60,000 to just £10,000.
This can significantly limit your ability to rebuild pension savings later if your financial circumstances change.
And let's not forget longevity. At age 55, life expectancy stretches another 30 years or more.
With such a long time horizon, the benefits of compounding inside a pension wrapper are hard to beat.
For someone who doesn't need the funds urgently, leaving the money invested in a pension could result in significantly higher long-term value.
Converting pension wealth to Isa capital purely to try and dodge future tax could prove an expensive misstep
Ultimately, this kind of planning should be objective-led. If the aim is intergenerational wealth preservation, pensions still hold the upper hand.
If the goal is accessibility and spending flexibility, Isas have a role.
But converting pension wealth to Isa capital purely to try and dodge future tax could prove an expensive misstep.
We'd advise waiting until we have certainty on how the 2027 reforms will be implemented before making any drastic changes.
That said, if someone has a very large pension and looked set to go over the previous lifetime allowance, then the amount of tax-free cash available to them may now be capped.
Under current rules, the maximum amount that can be withdrawn tax-free is generally limited to £268,275.
In those instances, it may be sensible to begin building Isa wealth from other savings or income sources, rather than adding more to the pension.
This can provide greater tax-free accessibility later in life while preserving the pension's longer-term tax benefits.
How much is inheritance tax and who pays?
Inheritance tax is levied at 40 per cent on estates above a certain size.
Your estate is the term given to all the things that you own at death. Valuing this involves adding up everything, from your stake in your home, to your savings and investments, your car and your personal belongings.
As an individual, your estate needs to be worth more than £325,000 for your loved ones to have to stump up inheritance tax.
This can be doubled to £650,000, jointly, for married couples or civil partners, who have not already used up any of their individual allowances.
A further crucial allowance, the residence nil rate band, increases the threshold by £175,000 each for those who leave their home to direct descendants.
This gives a total potential extra boost of £350,000 and creates a potential maximum joint inheritance tax-free total of £1million.
But the own home allowance starts being removed once an estate reaches £2million, at a rate of £1 for every £2 above the threshold.
