Is it possible to give away my pension savings to avoid IHT?

One of the biggest perks of defined contribution (DC) pensions is the fact that when you die, any money that you have left – that hasn’t been converted into an annuity – can be passed on to the beneficiaries of your choice.

The knowledge that you can pass your hard-earned savings to whoever you wish can provide immense peace of mind – especially if you have health problems or are worried you won’t get the full benefit of your pot yourself.

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The fact that these pots – currently – escape inheritance tax (IHT) has provided the icing on the cake and meant that many individuals facing an IHT liability have opted to spend other assets, that will be subject to the tax, first.

However, now that the chancellor has confirmed her plans to remove the IHT exemption for pensions from April 2027, many people who have been avoiding spending their pensions are suddenly finding themselves forced to rethink their plans.

Without any action, inherited pensions could become subject to double taxation. In addition to IHT at a rate of 40%, if the death occurred at age 75 or older, the pot will also be subject to income tax at the beneficiary’s marginal rate.

This could see a basic-rate taxpayer facing an effective tax rate of 52%, when they inherit a pension, rising to 64% and 67% for higher and additional rate taxpayers respectively.

One of the simplest ways to mitigate an IHT bill – on paper at least – is to give away money during your lifetime. Done effectively it means beneficiaries get the full benefit of your generosity, without losing 40% to tax.

Can you give away a pension to mitigate or reduce your IHT bill?

If you are confident that you won’t need the money – there’s nothing to stop you giving away all or part of a pension. However, doing so tax-effectively may be easier said than done, especially where larger sums are concerned.

Let’s look at the options – and the potential tax ramifications, you’ll need to consider.

You can’t transfer your pension into someone else’s name – to give it away, you would need to take the money out yourself to pass it on.

If you haven’t, as yet accessed your pension or taken your tax-free cash, you could withdraw a lump sum worth 25% of your pot and give that money away. But, if that ship has sailed, you could still withdraw lump sums, but your withdrawal would be added to your income for the year and taxed at your marginal rate – potentially bumping you into a higher-rate tax bracket and undoing your saving. That means withdrawals would need to be managed carefully and would be less beneficial if you already pay a higher rate of tax.

Even if you were able to give away tax-free cash, there would still be considerations to make if you want to avoid IHT.

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Gifting allowances let you to give away £3,000 a year to whoever you like and that money will be immediately be considered to be outside your estate for IHT purposes. And, if you didn’t use last year’s allowance, you can carry that forward meaning you could give away £6,000 in one go. If you have a child getting married you can also give them up to £5,000 tax free (£2,500 to children and great-grandchildren and £1,000 to anyone else).

Beyond that lump sum gifts would be considered potentially exempt transfers, which means you would need to survive for a further seven years before the gift became wholly free of IHT. But as Jo Summers, co-head of private wealth at law firm Jurit and spokesperson for STEP, points out “you can also take out a term insurance policy to cover that”.

Another option, she suggests, is to take advantage of the regular gifts from surplus income exemption. “There is no maximum cap on the income you can give away, so it can be a good way of getting money out of your estate.” You just need to be able to demonstrate that the money you gave away was not from capital and that making the gifts did not have a detrimental impact on your standard of living.

But again, income withdrawals from pensions are subject to income tax, so basic-rate taxpayers would want to avoid jumping up a tax bracket, with higher-rate tax equivalent to IHT at 40%.

Whichever way you look at it, giving away a pension in your lifetime could be a tax minefield. In circumventing IHT, you could inadvertently end up paying more income tax.

Skipping a generation?

However, there might be some ways to reduce tax charges on inherited pensions, without giving them away during your lifetime.

This also reduces the risks posed by giving away money you may come to need further down the line.

Jon Greer, head of retirement propositions at Quilter, cautions against getting carried away with lifetime gifts. “Lots of people underestimate how long they will live and care costs can motor through any remaining funds you have left.”

But rather than leaving your remaining pension funds to your adult children when you die – who will likely be working and paying income tax, potentially at the higher or additional rate already – you can reduce the tax paid by your heirs by skipping a generation.

If you have grandchildren, for example, they will have the same personal allowance as their parents, but are much less likely to have used it. That means they could, potentially inherit up to £12,570 each before any income tax would be payable, with anything over that hopefully remaining within the basic-rate tax band.

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But note – it’s only the rules around IHT and pensions that are changing in April 2027. If you die before age 75, no income tax would be payable by your beneficiaries, irrespective of whether it goes to your children, grandchildren or anyone else.

You can tell your pension provider who you would like to inherit your pension by completing an expression of wishes form. You don’t have to pick one beneficiary either and can split funds between a number of people.

It’s also worth checking what options will be available to your beneficiaries in terms of how they access an inherited pension. The option for them to use beneficiary drawdown may help them manage tax on withdrawals but some schemes may offer only a lump-sum death benefit. “Sometimes when grandparents are leaving money to teenagers or those in their early 20s, they like to leave an income stream, rather than capital,” adds Summers.

For many people it may be more practical to give away other assets in lieu of pensions to reduce your overall IHT charge and spend pensions yourself.

You may also want to think about leaving money to charity. If you leave 10% of your chargeable estate to charity, the rate of IHT is reduced from 40% to 36%.

Think carefully before taking action

However, before you make any drastic changes to your plans, it’s worth bearing in mind that IHT charges on pensions are not scheduled to come into force in April 2027.

The process of deducting IHT from pensions currently looks fiendishly complicated – involving collaboration between pension providers, HMRC and potentially unwitting executors. As such, the proposals are under consultation and we’re still a way off seeing draft legislation.

Making changes before that legislation is finalised could be high risk. “Charging IHT and income tax on a pension is punitive and we are hoping Number 11 will see the light on that,” says Summers.

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Greer thinks Labour will stick to its guns. “It will be very difficult to make a U-turn,” he notes. That said, he stresses that people shouldn’t make any knee-jerk decisions, until we have more clarity. “We’re a few years away from this coming in and there’s still ambiguity. It should become clearer in the next few months.”

There was a climate of fear in the run-up to the Budget and numerous investors are now paying the price for acting rashly, for example taking out all their tax-free cash before they needed it, because they were worried a new cap was going to be introduced.

Once we know exactly what will happen, it will be easier to make plans. In the meantime, if you are worried about IHT and want to take steps to reduce the bill your loved ones will face, it makes sense to speak to a regulated financial planner.