Spend the pension last?

Rethinking efficient client drawdown cadence…before April 2027!

For years, the default for wealthier clients has been to spend other assets first and leave the pension until last. It sat outside the estate for inheritance tax, and its long time horizon gave short-term market falls time to recover.

From 6 April 2027, both assumptions change. Unused pension funds will count towards the estate for inheritance tax (IHT). If death comes at 75 or over, what’s left can be taxed twice: IHT on the estate, then income tax when the beneficiaries draw it. In the illustrations below, where death came after 75, families were £180,000 to £230,000 better off when the client drew on the pension sooner, up to the top of the basic-rate band each year.

In my view, there’s a catch. Drawing sooner shortens the pension’s investment horizon, making it the income pot, and moves wealth into ISAs, so an early market fall costs the family more than if they drew from the pension last. The tax case still survives a bad start, but each pot’s investment strategy needs to change with it. The right order still depends on marital status, life expectancy, estate size and income needs.

WHAT CHANGES IN APRIL 2027

For deaths on or after 6 April 2027, most unused pension funds and death benefits will be included in the estate for IHT, under the Finance Act 2026. Personal representatives report and pay any tax, and can ask the scheme to pay HMRC directly within 35 days.

Some benefits stay outside the new rules:

dependants’ scheme pensions
dependants’ and joint-life annuities
death-in-service benefits
lump sums paid to charity

A note on timing: HMRC’s final guidance and some regulations are still to come, and the October Budget measures will be legislated in Finance Bill 2026/27. Details may change before April 2027.

COUPLES: THE SPOUSE EXEMPTION CHANGES THE PICTURE

Pensions left to a surviving spouse or civil partner remain exempt from IHT, as with other assets passing between them, provided the survivor is a long-term UK resident. Where they are not, the exemption may be restricted.

For most married clients, the pension carries no IHT on first death. The exposure moves to the survivor’s estate, so drawdown order for couples is a question about both lives.

FOUR DRAWDOWN ORDERS COMPARED

The illustrations compare four ways of funding retirement income. The last two both draw on the pension sooner than the traditional approach:

Pension last: spend savings first and draw on the pension only once they run out.
Balanced: fund each year’s shortfall half from savings and half from the pension.
Pension earlier: fund the shortfall from the pension first, keeping savings in reserve.
Fill the band: each year, take enough from the pension to bring taxable income, including the State Pension, up to £50,270, the top of the basic-rate band. Spend what’s needed and put any surplus into ISAs.

Both illustrative households start at 70 with a £500,000 home passing to their children, £350,000 in ISAs and other savings, and a £600,000 defined contribution pension. Case A is a single client spending £40,000 a year after tax, dying at 85 (or 73 as a comparison). Case B is a couple spending £50,000 a year, falling to £40,000 for the survivor, with deaths at 80 and 88.

Case	Order	Estate at death	IHT	Income tax on inherited pension	Net to beneficiaries	Income tax paid in life
A: single, dies at 85	Pension last	£1,755,000	£502,000	£294,000	£959,000	£17,000
A: single, dies at 85	Balanced	£1,704,000	£481,000	£197,000	£1,026,000	£52,000
A: single, dies at 85	Pension earlier	£1,643,000	£457,000	£83,000	£1,103,000	£97,000
A: single, dies at 85	Fill the band	£1,617,000	£447,000	£31,000	£1,139,000	£113,000
A: single, dies at 73	Pension last	£1,516,000	£407,000	£0	£1,109,000	£0
A: single, dies at 73	Balanced	£1,508,000	£403,000	£0	£1,105,000	£8,000
A: single, dies at 73	Pension earlier	£1,500,000	£400,000	£0	£1,100,000	£15,000
A: single, dies at 73	Fill the band	£1,491,000	£396,000	£0	£1,095,000	£23,000
B: couple, deaths at 80 and 88	Pension last	£1,809,000	£324,000	£338,000	£1,147,000	£68,000
B: couple, deaths at 80 and 88	Balanced	£1,776,000	£310,000	£234,000	£1,232,000	£80,000
B: couple, deaths at 80 and 88	Pension earlier	£1,637,000	£255,000	£50,000	£1,332,000	£187,000
B: couple, deaths at 80 and 88	Fill the band	£1,680,000	£272,000	£31,000	£1,377,000	£139,000

Illustrative figures, rounded to the nearest £1,000 (with IHT adjusted by up to £1,000 where needed so each row adds up), in money terms at death, calculated in annual steps. Net to beneficiaries is the estate less IHT and income tax on the inherited pension. Assumes 4% investment growth after charges, 2.5% house price and spending growth, the full new State Pension rising 3% a year, 25% of each withdrawal tax-free (none for a surviving spouse drawing an inherited pension), ISA top-ups within the £20,000 annual allowance per person, frozen tax thresholds, and beneficiaries paying 40% income tax. Tax on general investment accounts is ignored. Not projections or recommendations.

What the numbers show

Drawing sooner leaves families more, with death coming after 75. Filling the basic-rate band left £1,139,000 for the single client’s family against £959,000 under pension last, a difference of £180,000. For the couple, the gap was £230,000.

The double charge drives it. Under pension last, the single client’s pension grew to just over £1 million and was taxed twice: IHT, then £294,000 of income tax at the beneficiaries’ rate.

After 75, filling the band beats pension earlier. Taking pension income at the basic rate now (an effective 15% on the client’s own pension, with a quarter tax-free), and moving any surplus into ISAs, is cheaper than leaving it to be taxed twice later. For the couple, it also kept the survivor out of the higher-rate tax band. Withdrawals from an inherited pension are fully taxable, so funding all of the survivor’s spending from it, as pension earlier does, pushed them into the higher-rate band: £187,000 of lifetime income tax, against £139,000 when filling the band.

There is a cost during the client’s lifetime. Filling the band meant paying £113,000 of income tax over retirement, against £17,000 under pension last, where income came mainly from tax-free ISA withdrawals. The family gains more later, but some clients will reasonably prefer to pay less tax now.

Early death tips the result the other way. At 73, pension last came out £14,000 ahead of filling the band, because pensions inherited before 75 are generally free of income tax.

THE PENSION’S HORIZON SHORTENS, AND THE RISK MOVES WITH THE MONEY

Under pension last, the pension sat untouched for years while savings funded income. Drawing on it sooner changes two things. The pension becomes the income pot, so it needs investing for withdrawals rather than for the long term. Wealth also moves out of the pension into ISAs. ISAs still face IHT, but not the extra income tax charge on an inherited pension, so more of any market fall lands on the family.

To test this, the figures for the single client dying at 85 (Case A) were rerun with a 20% fall in pension and savings in the first year of retirement:

Order	Net to beneficiaries (from the table above)	After a 20% fall in year one	Cost of the fall
Pension last	£959,000	£822,000	£137,000
Balanced	£1,026,000	£860,000	£166,000
Pension earlier	£1,103,000	£941,000	£162,000
Fill the band	£1,139,000	£953,000	£186,000

Same assumptions as above, with pension and savings both falling 20% in the first year, then growing at 4%. Cost of the fall is the reduction in net to beneficiaries at death: the fall itself, plus the growth the lost money would have earned, less the share that would have gone in tax.

What this shows:

The tax case survives a bad start. Even after the fall, filling the band still left the family the most. The same was true for the couple.
But the fall costs more. Money left in the pension until a death after 75 faces IHT and then income tax, so the family only ever receives about a third of it. In an ISA, it receives around 60%, after IHT. So a £100,000 fall inside the pension costs the family about £33,000, while the same fall in an ISA costs about £60,000.
And filling the band moves money into ISAs. By 85, it had moved most of the family’s wealth there (£785,000, against £108,000 left in the pension), so the same fall cost £186,000 against £137,000 under pension last. For the couple, it was £207,000 against £151,000.
Timing matters. Early falls cost more, mainly because the lost value would otherwise have grown for longer. A 20% fall in the final year cost the band-filling family £121,000, against £186,000 in the first year. The same applies under pension last (£84,000 against £137,000).

Falls like this are normal: over the 40 years to 2025, global equities saw an average intra-year fall of 14.6%, yet 29 of those years still finished positive (MSCI World, 1986 to 2025). The practical point for advisers is that drawing sooner changes the job each pot is doing. Whichever pot funds the next few years of withdrawals needs investing for that role, for example with a cash or lower-volatility buffer. And money building up in ISAs no longer has the inherited-pension income tax charge to absorb part of a fall, so how it’s invested matters just as much.

OTHER CHANGES TO FACTOR IN

The residence nil-rate band. Pensions now count towards the £2 million taper, so a large pension can reduce or remove the RNRB.

Nominations. Beneficiary drawdown depends on scheme rules and up-to-date nominations, so review them before April 2027.

Income tax relief. No income tax is charged on the part of an inherited pension equal to the IHT paid on it. This prevents tax on tax, but the combined burden after 75 can still be high.

AFTER THE 28 OCTOBER BUDGET

The Budget confirmed the April 2027 changes and left the IHT rate and £325,000 nil-rate band unchanged. Two related changes:

The two-year rule has gone. Death benefits paid more than two years after the scheme learns of a death no longer become taxable for that reason alone, for payments from 28 October 2026.
Prospective personal representatives can direct a scheme to pay IHT to HMRC where there is no will or named executor.

THINGS TO LOOK OUT FOR

For clients currently following a pension-last strategy, these are worth raising. The list isn’t exhaustive:

Is the client married or in a civil partnership, and is their spouse a long-term UK resident?
How likely is the client, or the survivor, to live beyond 75?
Does the estate, including pensions, exceed £2 million?
Are pension nominations and expressions of wish up to date?
Is the client using their basic-rate band each year, and is there ISA allowance for any surplus?
Is the money needed for the next few years’ withdrawals invested to cope with a market fall?
Is the reasoning for the chosen order recorded in the client file?

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FREQUENTLY ASKED QUESTIONS

When do pensions come into IHT? For deaths on or after 6 April 2027.

Does it apply to deaths before April 2027? No, even if benefits are paid out later.

Is a pension left to a spouse or civil partner exempt? Yes, where the survivor is a long-term UK resident. The exemption may be restricted if they are not.

IMPORTANT INFORMATION

This article is for professional financial advisers only and should not be relied on by retail investors. It does not constitute advice or a recommendation. The case studies are illustrative, based on the assumptions stated, and do not predict future outcomes. Some of the rules described are based on draft legislation and guidance that may change before they take effect. Tax rules can change, and their effect depends on individual circumstances. The value of investments can fall as well as rise.