Using Pension Drawdown to Minimise Your IHT Liability

For many people approaching or in retirement, the question of how to draw from their pension has always been about balancing income needs with tax efficiency. From April 2027, a new dimension enters that calculation: Inheritance Tax.

With unused pension funds set to become part of the taxable estate, the order in which you draw from different assets — and how much you take from your pension each year — will have a direct bearing on the IHT bill your family faces.

The old logic vs the new logic

Under the old rules, the conventional wisdom for many higher-value estates was straightforward: spend everything else first, preserve the pension. Because pensions sat outside the estate for IHT purposes, leaving a large pension pot to pass to your children or grandchildren was one of the most tax-efficient things you could do.

From April 2027, that logic is reversed. A large, untouched pension pot will now attract IHT at 40% on death. The incentive to preserve it has been significantly reduced.

The new drawdown priority order

For many estates, the new optimal order for drawing assets in retirement will look something like this:

1. State Pension and defined benefit income — these are fixed and cannot be deferred, so they form the base layer of income
2. Pension drawdown — draw from your defined contribution pension earlier and more actively than you might have done previously
3. ISAs and other investments — these remain outside the estate (though ISA IHT rules are also changing)
4. Property and other assets — depending on your circumstances and wishes

This is a generalisation — the right order for you depends on your tax position, income needs, and estate planning goals. But the principle is clear: the case for leaving your pension untouched has weakened considerably.

How much should you draw?

Drawing more from your pension reduces the pot that will be subject to IHT — but it also creates income tax liability, reduces the pension pot available for your own retirement income, and may affect means-tested benefits. The goal is not to empty your pension as quickly as possible. It is to draw at a rate that balances your income needs, your tax position, and the IHT efficiency of your overall estate.

Our Pension Drawdown Calculator can help you model different drawdown rates and see the impact on your projected estate value and IHT liability.

The interaction with income tax in Scotland

For Scottish taxpayers, the higher rate of 42% kicks in at £43,662. If your total income is already close to the higher-rate threshold, additional drawdown will be taxed at 42% or above. In that scenario, the IHT saving from drawing down may be partially offset by the income tax cost.

The sweet spot is often to draw enough from your pension each year to use up your basic-rate band, without tipping into higher-rate territory. This requires careful modelling and regular review.

Gifting from drawdown

One strategy worth considering is using pension drawdown income to fund gifts to family members. If you draw from your pension and immediately gift the proceeds, you are reducing the pension pot (and therefore the future IHT liability) and starting the seven-year clock on a Potentially Exempt Transfer.

Gifts from surplus income — regular gifts that do not affect your standard of living — can also be exempt from IHT immediately, without the seven-year wait. If your drawdown income exceeds your living costs, this can be a highly efficient way to pass wealth to the next generation.

Reviewing your expression of wishes

With the IHT rules changing, it is also worth reviewing your pension nomination. Previously, leaving your pension to adult children was often the most tax-efficient option. From 2027, the spousal exemption may make it more attractive to leave the pension to a spouse or civil partner first, with the children inheriting other assets. This is a nuanced decision that depends on the ages and tax positions of all parties involved.

The case for a drawdown strategy review

If you are currently in drawdown — or approaching the point where you will start drawing from your pension — the April 2027 changes are a compelling reason to review your strategy. The questions to ask are:

• Am I drawing enough from my pension, or am I building up a pot that will face a large IHT bill?
• Is my current drawdown rate tax-efficient, or am I paying more income tax than necessary?
• Have I reviewed my expression of wishes in light of the new rules?
• Am I making use of gifting allowances and surplus income exemptions?

SBC Financial is authorised and regulated by the Financial Conduct Authority (FCA ref: 997666). The value of investments can fall as well as rise. Tax treatment depends on individual circumstances and may be subject to change. This article is for information purposes only and does not constitute personal financial advice.