Should I use my pension to make lifetime gifts?

Many people would like to help their children or grandchildren financially during their lifetime rather than leaving everything to them after they have died. Whether it is helping with a house deposit, supporting a family member, or simply giving loved ones a financial boost, making lifetime gifts can be a rewarding way to pass on wealth.

With the proposed changes from 6 April 2027, which will bring most unused pension funds and death benefits within the scope of Inheritance Tax (IHT), more people are asking whether their pension could be used to make those gifts instead.

While this may be appropriate for some families, the decision is not straightforward. Before withdrawing money from your pension to make gifts, it is important to consider the Income Tax consequences, the Inheritance Tax rules and your own future financial security.

The Income Tax cost of accessing your pension

One of the first considerations is the tax payable when you withdraw money from your pension.

For most defined contribution pensions:

• The first 25% of most withdrawals is usually tax-free.

• The remaining 75% is taxed as income at your marginal rate.

  
  

Taking a large lump sum could push you into a higher Income Tax band, increasing the amount of tax you pay.

This means that withdrawing pension funds simply to reduce a future Inheritance Tax liability may not always achieve the expected result. The immediate Income Tax cost of taking money from your pension could outweigh any potential IHT saving.

Making lifetime gifts

Once pension funds have been withdrawn, you are free to gift the money to family members or others.

Most lifetime gifts are treated as Potentially Exempt Transfers (PETs). If you survive for seven years after making the gift, it will usually fall outside your estate for IHT purposes.

If you die within seven years, the value of the gift may still be taken into account when calculating the IHT payable on your estate.

Many people have heard of taper relief and assume it automatically reduces the tax on gifts made more than three years before death. However, this is often misunderstood.

Taper relief reduces the amount of IHT payable on a gift — it does not reduce the value of the gift itself. It only applies where the gift exceeds the available nil-rate band and creates an actual IHT liability. As many lifetime gifts are covered by the nil-rate band, taper relief often has little or no practical effect.

Depending on your circumstances, you may also be able to make use of annual gifting exemptions and other available reliefs.

Don’t forget your own future needs

Before making significant gifts, it is important to consider your own financial security.

Your pension is designed to provide income throughout retirement, and once money has been gifted it cannot usually be recovered. It is therefore important to ensure that any gifts do not affect your ability to maintain your own standard of living in the future.

It is also important to consider the potential impact of future care costs.

If you later require residential or nursing care, your local authority may consider whether you deliberately gave away assets to reduce the amount you would have to contribute towards care fees.

Unlike Inheritance Tax, there is no seven-year rule for care fee assessments. Instead, the local authority will consider the circumstances at the time the gift was made, including your financial position, health and the reasons for making the gift.

Is using your pension to make gifts the right approach?

The proposed changes from April 2027 mean pension and estate planning is becoming more complex.

Although pensions are expected to lose some of their previous Inheritance Tax advantages, this does not automatically mean that withdrawing funds and making gifts is the right solution.

Every individual's circumstances are different. The potential Income Tax cost of accessing your pension, your retirement income needs, your estate planning objectives and possible future care costs all need to be considered together.

Careful planning can help ensure that any decisions made are appropriate for both you and your family.

A note about financial advice

We are not authorised to provide financial advice. Any decision to access your pension or make gifts from pension funds should be discussed with a suitably qualified financial adviser, who can assess your individual circumstances and recommend the most appropriate course of action.

If you do not already have a financial adviser, we would be happy to put you in touch with a trusted independent financial adviser who can provide the advice you need before any decisions are made.

If you would like to discuss the tax implications of lifetime gifting or how these changes may affect your estate planning, please get in touch with us.

You may also find our previous article, “Pension withdrawals and consolidations – the importance of getting the right advice”, useful, as it covers some of the wider tax and financial considerations to think about before accessing your pension.