Pensions: a solid choice for your clients’ retirement savings

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From 6 April 2027, a major shift in pension taxation will take effect: most unused pension funds and death benefits will be drawn into the scope of Inheritance Tax (IHT). In this article, we explore why pensions are still a good investment to provide retirement funds and how advisers can adapt their planning conversations to stay ahead of the curve.
 

ISAs vs pensions

ISAs are perhaps the closest product to compare pensions against as both are income tax and capital gains free, and from April 2027 both will be subject to IHT.

Pensions enjoy the benefit of tax-relief on contributions. ISAs on the other hand enjoy the benefit of unlimited tax–free withdrawals along with unrestricted access to benefits.

Feature	ISA	Pension
Eligibility	UK resident aged 18 +	Anyone (individual scheme rules may impose restrictions)
Annual Contribution Limit	£20,000	Unlimited (limit on how much qualifies for tax relief)
Government Bonus/Tax relief on contributions	None	Tax relief at marginal rate up to 100% of earnings or £3,600 if greater. Tax charge applies on excess over the annual allowance limit (£60,000 in 2025/26).
Employer Contributions	None	Unlimited Tax charge applies on excess over the annual allowance limit.
Tax on Withdrawals	100% tax-free	25% tax-free, rest taxed as income at marginal rate
Access Age	Anytime	From age 55 (rising to 57 by 2028) Can be accessed early for those in ill health

 

Wealth transfer comparisons

With pensions exposed to IHT from April 2027, and death benefits after age 75 also incurring income tax—it might appear that ISAs, which are only subject to IHT, offer a more efficient route for passing on wealth. 

However, the current draft IHT proposals have confirmed that income tax will not be charged on pension funds used to pay IHT. As a result the maximum inheritance tax charge that can apply is 40%, which is the same as for the ISA.  

The tax relief available on pension contributions therefore continues to offer a monetary benefit that is not available to the ISA. 
 

 

Death benefits

If a client dies before age 75 both the pension (if death is on or after 6 April 2027) and the ISA will be subject to IHT. The pension will however normally return a higher amount. This is because of the tax relief that is added to the initial investment. 

If the client dies after age 75 then it is still the case that both the pension and the ISA will be subject to IHT. Where IHT applies then it remains the case that a pension will normally return a higher amount than an ISA. 

Where there is no IHT to apply then it will depend on the marginal tax rate of the beneficiary whether the ISA or the pension return a higher amount. This position is unchanged from today and highlights the importance of regularly reviewing nominations for death benefits.

 

Things to think about:

• Beneficiaries may be in peak earning years, facing higher marginal rates. A large lump sum could push them into the additional rate band, while ISA withdrawals remain tax-free. 
   
• Nominating grandchildren to benefit could be tax efficient and prevent a growing IHT liability for the next generation. 
   
• Nominees and Dependants aren’t usually required to draw funds immediately as a lump sum from a pension. They can leave assets in beneficiary drawdown and withdraw strategically to top up income as needed and not exceed higher tax rate thresholds. This also has the advantage of keeping the full value (after IHT) in a tax efficient pension wrapper. 
   
• ISAs, by contrast, must be distributed (unless left to a spouse) and form part of the estate.

 

Keeping nominations up to date

Maintaining up to date pension nominations is crucial to make your pensions as efficient as possible. Pension benefits left to a spouse/civil partner continue to benefit from the existing exemption to IHT. This can allow more time to plan around any IHT implications, and combining assets and nil rate bands may help to mitigate IHT. This planning flexibility won’t be available for non-married partners or single people.

If your pension is paid to an adult child or cohabiting partner you have not nominated and they are not a dependant, they won’t have the ability to take beneficiary drawdown; they will therefore have to receive a lump sum.

Nominations are therefore essential not just to ensure who receives the benefits, but also to provide the necessary income tax flexibility.