Major changes are coming that could transform how your pension can be used to support your family – and they may leave you facing unexpected tax bills. If you’ve always thought of your pension as a safe, tax-efficient way to pass on wealth, it’s time to think again. New rules announced by the government mean your pension wealth will become less effective as a tax-efficient gifting tool.
What’s changed in 2025?
In the 2024 Autumn Statement, the government declared that they are determined to prevent pensions from being used purely as an IHT shelter. This means that pensions will be subject to inheritance tax from April 2027.
What does this mean for you? It means that leaving your pension untouched until death may no longer be the smart move. Instead, there is a growing shift towards using your pension wealth while you’re alive – not just for your own needs, but to support family members, help younger generations with education costs, or provide a house deposit.
Could your pension help you gift more – and pay less Inheritance Tax?
If you’ve worked hard to build up a pension pot and are now thinking about your legacy, you may be wondering whether there’s a smart way to use your pension to support your loved ones without waiting until you’re gone. With Inheritance Tax applying at 40% on many estates, and growing pressure on families to plan more effectively, the idea of using pension cash as a tax-efficient gifting tool has become more relevant than ever.
Understanding the basics: tax-free cash from your pension
You’re generally allowed to take up to 25% of your pension pot as tax-free cash if you have a personal pension (such as a self-invested personal pension or another defined contribution scheme). Some people take this as a lump sum at retirement, but others choose to draw smaller amounts over time, especially if they don’t need the full amount all at once.
This tax-free portion, sometimes referred to as the Pension Commencement Lump Sum (PCLS), can be accessed either all at once, or in stages through a drawdown plan. Importantly, you can often structure your withdrawals so that each one includes a portion of tax-free cash, alongside any taxable income from the taxable portion of the fund.
Can you make gifts with that tax-free cash too?
Yes – and here’s where it gets interesting. Regular gifts from income are permitted by HMRC, and if specific requirements are fulfilled, they are entirely excluded from inheritance tax. This exemption is referred to as “normal expenditure out of income”. Traditionally, it applied to things like salary, rental income or investment dividends, but more recently, pension tax free cash has entered the picture.
A number of pension providers have reported that HMRC will accept regular withdrawals of pension tax-free cash as “income” for this purpose. That means if you take regular withdrawals of tax-free cash from your pension and gift that money to, say, your children or grandchildren, the gifts will not count towards your estate at all, no seven-year clock, no £3,000 annual limit, and no tax bill later down the line.
What’s the catch?
There are a few key conditions to meet. First, the gifts must be part of a regular pattern. For example, monthly, quarterly or annually. A one-off gift won’t qualify. Second, you need to be able to show that the gift came from your surplus income – in other words, that you didn’t need the money for your own living costs. Third, and perhaps most importantly, you need to keep clear records to prove what you did and why, so keeping household accounts to demonstrate both the regularity of the gifts and that they are genuinely not needed for your living costs is sensible.
If these conditions are met, the tax benefits can be powerful. You’re able to help your family now, on your terms, while also quietly reducing the size of your estate, and therefore the amount that could be taxed when you pass away.
A quick real-world example
Let’s say you withdraw £10,000 in tax-free cash from your pension every year. You don’t need that money yourself, so you gift it to your two children. Because you do this every year, and you can show that your other income is sufficient to support you, the gift may qualify under the “normal expenditure out of income” exemption. That means the full £10,000 is out of your estate immediately. Over 10 years, you could reduce your estate by £100,000, potentially saving your family £40,000 in Inheritance Tax.
Final thoughts
For anyone with a sizeable pension pot and a desire to support family during life, not just in death, this is a valuable planning opportunity. It combines flexibility, generosity, and tax efficiency in a way that few other strategies can. But the rules are nuanced, and the paperwork matters, so don’t go it alone.
Instead, speak to a professional who understands the interaction between pensions, income, and inheritance tax. With the right advice, your pension can do more than fund your retirement, it can shape your legacy, too.
