Pension or ISA first? The 2027 IHT case for changing withdrawal order

The answer to “should I draw my ISA or pension first?” used to be straightforward: use the ISA and let your pension savings grow untouched. That's changing. From 6 April 2027, most unused pension funds will be included in a person’s estate for inheritance tax (IHT) purposes, and many estates may need to pay inheritance tax on pension wealth for the first time. 

If your estate is likely to exceed the nil rate band, drawing your pension more quickly and spending or gifting those funds could reduce what your pension beneficiaries pay. 

Key takeaways 

• From April 2027, most unused pension funds will face IHT at 40% above £325,000.
   
• Drawing your pension earlier can cut the IHT and income tax your beneficiaries pay.
   
• The ISA-first rule still applies if your estate won’t exceed the available nil-rate bands.
  
  
• Faster drawdown only makes sense when income tax cost is lower than IHT saved. 

At Netwealth, our financial planners help clients navigate the inheritance tax changes on pensions and restructure their withdrawal strategies in a tax-efficient way. Speak to our team today. 

This guide covers which estates should reverse the rule, how to model the numbers, and when to hold your current approach. 

Why the “spend ISA first” rule existed 

​​​Crucially, most pension assets didn’t form part of a deceased’s estate for inheritance tax purposes. Most discretionary schemes let you nominate beneficiaries and pass the pot outside the member’s estate free of IHT, giving them a unique tax-free status. 

Under those rules, pension beneficiaries could draw remaining benefits tax free if the holder died before 75. After 75, beneficiaries paid income tax but still no IHT. 

What the inheritance tax changes mean for pension holders 

​​In the ​Autumn Budget 2024, the government announced that from 6 April 2027, most unused pension funds and pension death benefits will be included in the value of a person’s estate for Inheritance Tax purposes, which may necessitate a re-evaluation​ of estate planning strategies for individuals with significant pension wealth. 

The government’s rationale was to end pensions being used as a tax planning vehicle to transfer wealth. HM Revenue and Customs published its response in July 2025, confirming the approach following a technical consultation that closed in January 2025. 

The government estimates 213,000 estates with inheritable pension wealth will be affected in 2027 to 2028: 10,500 face an inheritance tax liability for the first time and 38,500 will pay more. These are upper limit figures; the impact on bereaved families will vary. 

What remains exempt from inheritance tax on pensions 

Not everything changes. The following remain outside the scope of the new IHT rules: 

• Pensions passed to a surviving spouse or civil partner continue to pass free of IHT. 
  
  
• All death in service benefits from registered pension schemes are excluded from IHT from April 2027, whether the scheme is discretionary or non-discretionary. This was confirmed by HMRC in July 2025. 
  
  
• Dependant’s scheme pensions paid as ongoing income are not in scope. 
  
  
• Gifts to registered charities remain fully IHT-exempt. Estates leaving 10% or more to charity qualify for a reduced IHT rate of 36%. 

Which estates should consider changing withdrawal order 

Understanding the nil rate band and residence nil rate band 

The standard nil-rate band for Inheritance Tax is £325,000, remaining frozen until 2029-30. The residence nil rate band (RNRB) of £175,000 is also available if you’re passing a qualifying home to direct descendants. 

For married couples or those in a civil partnership, the unused nil rate band transfers to the surviving spouse. The combined IHT-free thresholds available are: 

NRB and RNRB frozen until 2029-30. Source: GOV.UK / Autumn Budget 2024. 

Estates with assets above these thresholds will face IHT at 40% on the excess. From April 2027, your pension pot will be included in that calculation. 

Double taxation and the effective rate on inherited pension wealth 

The standard rate of Inheritance Tax is 40% on estates valued above the nil-rate band of £325,000, which will now include the value of pension funds from April 2027. The government's confirmed double taxation protection means pension funds used to pay IHT won't also face income tax, but it's not automatic.  

Beneficiaries need to instruct their pension provider to pay the IHT bill directly from the pension. If they don't, income tax may be charged on the withdrawal and will need to be reclaimed from HMRC. Even so, the combined burden of IHT and income tax on remaining benefits can leave beneficiaries with significantly less than the original pot. 

Income tax applies to pension withdrawals at the beneficiary’s marginal rate, based on their total income for the ​​year: 

​​​​​​Source: GOV.UK income tax rates, 2026/27.​​​
Income tax rates above apply in England, Wales and Northern Ireland. Scottish taxpayers are subject to different rates and bands; see GOV.UK for details.​​​​​ 

Drawing your pension at your own marginal rate can mean more money reaches your family than leaving those funds to face 40% IHT and income tax on what remains. 

How to model the IHT saving against the income tax cost 

The calculation compares income tax paid now versus IHT plus income tax at death. The break-even depends on your marginal rate when drawing and your pension beneficiaries’ marginal rate. 

A worked example: inheritance tax and income tax combined 

Consider a pension pot of £500,000 where the deceased’s estate already exceeds the nil rate band. At 40% IHT, the charge is £200,000. Pension beneficiaries drawing the remaining £300,000 at 40% income tax face a further £120,000. Total tax: £320,000, leaving beneficiaries with £180,000. 

Compare that against drawing the pension within the basic rate band during your own retirement: 

 Illustrative example. The basic rate scenario assumes drawdown within the 20% band over approximately 13 years, resulting in roughly £98,000 in total income tax. Actual outcomes depend on individual circumstances, income sources, and beneficiaries’ tax positions. 

Drawing within the basic rate band can result in substantially more reaching your family, particularly where the seven-year gifting rule is satisfied for funds spent or gifted during your lifetime. 

Managing the personal allowance and basic rate band 

Accelerating pension drawdown works best within the basic rate band. The personal allowance of £12,570 is tax free in each tax year. The state pension (£12,548 for 2026/27) uses most of it; additional drawdown attracts 20% tax up to £50,270. 

Phased pension withdrawals let you stay within the 20% basic rate band while reducing pension savings that would otherwise face 40% IHT. Be cautious if drawdown pushes income above £100,000: the personal allowance tapers there, creating a 60% effective tax charge between £100,000 and £125,140. 

The estates and income levels where reversing the order makes sense 

Reversing the order is tax-efficient when your estate exceeds the combined nil rate band, your income tax rate on drawdown is lower than the IHT liability, and you have time to make potentially exempt transfers. 

It makes less sense if your estate is below your available nil rate band, or if faster drawdown pushes you into the higher rate or the £100,000 to £125,140 taper zone. 

Using tax-free cash and ISAs together 

You can take up to 25% of a defined contribution pension as a tax-free cash lump sum, capped at £268,275. Reinvesting into an ISA lets you access those funds tax-free during your lifetime, spending down your estate without creating an income tax charge. 

ISA savings count toward your estate at death, but withdrawals are tax free and capital gains tax doesn’t apply. Using pension tax-free cash to top up your ISA allowance (up to £20,000 per year) is a tax-efficient move. 

Using gifts, civil partner transfers and death benefit rules 

Individuals may consider the following strategies to reduce IHT exposure now that pension funds form part of the estate valuation: 

• Outright gifts to individuals: become fully IHT-exempt as potentially exempt transfers (PETs) after 7 years. 
  
  
• Annual gifting exemption: £3,000 per year is immediately IHT-exempt. 
  
  
• Gifts from surplus income: immediately exempt as normal expenditure out of income, with no upper limit, provided they come from your regular income. 
  
  
• Trust transfers: IHT treatment differs from outright gifts and requires specialist legal advice before proceeding. 

When to hold the current withdrawal order 

When your estate is below the nil rate band 

If your combined estate, including pension assets, falls below your available nil rate band and residence nil rate band, the 2027 changes do not create an IHT liability on your pension. The ISA-first approach remains correct: draw ISA savings, keep the pension growing, and pass it on without the tax cost. 

When the pension is likely to pass to a surviving spouse 

Pensions transferred to a surviving spouse or civil partner remain exempt from IHT under the 2027 rules. If your primary beneficiary is a spouse, the case for accelerating drawdown is weaker. Planning in this scenario is better focused on the second death, when the combined estate passes to children or grandchildren and the full nil rate band may already be in use. 

When to ask a financial adviser about defined benefit pensions 

Defined benefit pensions provide a guaranteed income rather than pension assets you can redeploy. The remaining benefits may include scheme pensions for a surviving spouse, and scheme trustees have discretion. The 2027 tax treatment of defined benefit pensions and the treatment of remaining benefits both require scheme-specific advice. 

Inheritance tax planning steps to take before April 2027 

Review your total estate value including pension assets 

Before April 2027, establish what your estate is worth with your pension included. If the combined total exceeds your available nil rate band, the new rules will create an IHT charge on the pension. This is the starting point for any planning. 

Check your pension beneficiary nominations 

From April 2027, personal representatives (executors) will be responsible for reporting and paying IHT on unused pension funds, working with pension scheme administrators and scheme trustees to value pension assets at death. If your nominations are out of date or missing, the pension may not pass as you intend. Confirm nominations are current with your pension provider before April 2027. 

Understand your beneficiaries’ tax positions 

The income tax your beneficiaries will pay on inherited pension funds depends on their marginal rate. A beneficiary in the basic rate band faces a very different combined burden than one paying additional rate tax. Understanding their likely position helps you model whether drawdown in your own lifetime reduces the total tax cost to your family. 

Model your drawdown strategy before the deadline 

If your estate exceeds your nil rate band and residence nil rate band, consider whether accelerating pension drawdown before April 2027 reduces the combined IHT and income tax burden. This requires modelling against your specific income, estate, and beneficiaries’ tax positions. Speak to a financial planner who can run the numbers across different scenarios before you commit to a strategy. 

Get more money to your family by restructuring before 2027 

The inheritance tax pension changes are a reason to revisit your drawdown strategy. For estates below the nil rate band, nothing changes. For those above it, a tax-efficient drawdown plan using tax-free cash and gifting means more money for bereaved families. 

At Netwealth, our financial planners model pension drawdown, inheritance tax planning, and income tax for your retirement. Our digital planning tools let you bring your pensions, ISAs and investments together in one place and model whether your retirement income will hold up. Find out more about our financial planning service or speak to our team today. 

Please note: the value of your investments can go down as well as up. Netwealth offers advice restricted to our services and doesn’t provide independent advice across the market. This article doesn’t constitute financial advice and shouldn’t be interpreted as a personal recommendation. Tax rules and thresholds are subject to change. 

Frequently asked questions 

Will my pension be subject to inheritance tax from April 2027? 

Under the new rules, from 6 April 2027 most unused pension funds and death benefits will be included in the value of a person’s estate. If your estate exceeds the nil rate band of £325,000, the excess is subject to IHT at 40%. 

Should I now draw my pension before my ISA because of the 2027 changes? 

It depends on whether your estate will have an IHT liability. If your estate, including pension assets, is below your nil rate band and residence nil rate band, the ISA-first rule still applies. If your estate exceeds those thresholds, drawing your pension earlier may mean more money reaching your beneficiaries. 

How many estates will be affected by the inheritance tax pension changes? 

The government estimates 213,000 estates with inheritable pension wealth will be affected in 2027 to 2028. Of those, 10,500 face an inheritance tax liability for the first time and 38,500 will pay more. These are upper limit figures. 

What is the nil rate band for inheritance tax? 

The nil rate band is £325,000, frozen until 2029-30. The residence nil rate band of £175,000 is also available for qualifying homes passed to direct descendants. Married couples and those in a civil partnership can combine allowances. Where a qualifying home passes to direct descendants, up to £1 million can be sheltered from IHT. 

Are death in service benefits included in inheritance tax from 2027? 

No. HMRC confirmed in July 2025 that all death in service benefits from a registered pension scheme are excluded from IHT from 6 April 2027, whether the scheme is discretionary or non-discretionary. Benefits held in non-pension trust structures are also unaffected. 

Can Netwealth help with inheritance tax planning and beneficiary nominations ahead of 2027? 

Yes. Keeping pension beneficiary nominations up to date is one of the most important steps before April 2027, and it’s something our financial planners review with every client. Find out more about our financial planning service. 

Read more from Netwealth 

• Who will inherit your pension? 
  
  
• How to shield your children from inheritance tax 
  
  
• How to minimise UK pension tax at retirement