Should You Take a Lump Sum from Your Pension to Avoid Inheritance Tax?

With inheritance tax back in the headlines, many people approaching retirement are rethinking their pension strategies. You may have noticed reports of record-breaking pension withdrawals, and it’s worth understanding what’s driving the trend — and what it could mean for your own plans.

Why Are People Taking Pension Lump Sums Now?

In the Autumn 2024 Budget, the government announced that from April 2027, most unused pension funds will be counted as part of your estate for inheritance tax (IHT). This marks a significant shift. Until now, many pensions could usually be passed on free of IHT, especially if death occurred before age 75.

Unsurprisingly, this change has fuelled concern. There’s also speculation that the current 25% tax-free lump sum (capped at £268,275) could be reduced in a future Budget. That uncertainty has led to a surge in withdrawals: more than £18bn was taken from pensions in the past year, up over 60% from the previous year.

Some people are hoping to “lock in” their tax-free cash now, or to move money before it risks being pulled into their taxable estate.

The New Rules: What’s Changing?

• From April 2027: Most unspent pensions and death-in-service benefits will be subject to inheritance tax at 40% if your estate exceeds the tax-free allowance.
• Tax-free cash at risk: There’s no change yet to the 25% tax-free lump sum, but many experts believe it could be a future target for the Treasury.
• Added complexity: Large lump sum withdrawals can create new income tax liabilities, affect future retirement income, and may trigger emergency tax charges.

Should You Act Now?

It’s tempting to rush into action, but there are important risks to weigh up:

• Income tax traps: Large withdrawals may push you into a higher tax band, creating an unexpectedly large bill.
• Loss of growth: Money removed from pensions no longer benefits from tax-free investment growth.
• Inheritance complications: Funds withdrawn and gifted may still face inheritance tax if the donor does not survive for seven years.
• Cash flow headaches: Emergency tax rates often apply to big withdrawals, with refunds sometimes taking months.
• Speculation isn’t certainty: While rumours abound, the government hasn’t confirmed any cuts to the tax-free lump sum. And the changes to inheritance tax on pensions don’t kick in for another year and a half yet, as at the time of writing. In the meantime pensions remain outside of your estate for IHT, so any action now could be premature.

Our Advice

Making snap decisions based on speculation can be costly. The wisest approach is to review your estate and retirement plans calmly, with the bigger picture in mind.

At Chesterton House, our Financial Planners have decades of experience and know pensions and inheritance tax inside out. We’ve helped hundreds of clients navigate shifting tax rules, always with the focus on protecting their future while giving them clarity and confidence. And because we work with our clients over the long term, we’re able to provide advice about future changes and strategies as personal circumstances, tax rates and charges, and economic conditions change over time.

If you’re already a Chesterton House client, rest assured we’ll be building these changes into your Plan and keeping everything up to date.

If you’re new to us and wondering whether to take action, let’s talk it through together. With a clear plan, you can respond to the changes without losing sight of what matters most — your long-term financial security and the legacy you want to leave behind.

📞 Get in touch today to book a free conversation with one of our qualified Financial Planners.