The pension mistakes that could cost your family thousands

Financial advisers have shared the pension mistakes that could cost your family including rushing to withdraw savings and giving money away without a plan.

Their message to people approaching retirement is to look beyond inheritance tax before making costly changes.

For many savers, the worry is how much of their pension will eventually reach their children. But focusing on that alone risks overlooking what the money needs to provide first: an income that could have to last for decades.

Taking money out of a pension is not automatically a way to protect an inheritance. Withdrawals can trigger income tax, while money moved into a bank account may still form part of your estate when you die.

From 6 April 2027, most unused pension funds and pension death benefits will count towards your estate for inheritance tax, rather than generally sitting outside it. This means pension savings could face a 40% charge where your estate exceeds the available tax-free allowances.

Financial advisers told Newspage that the starting point should be a picture of your finances, including pensions, ISAs, property and other income.

Should you take money out of your pension because of inheritance tax?

Richard Squire, Founder and CEO at London-based MyFinanceFuture, said mistakes can be costly.

He added: “We’ve seen many people take up cashflow planning over the last two years in response to the pensions inheritance tax change. It’s causing many to switch to draw on pension assets first when funding retirement, not last. This has big implications for tax in retirement, with the potential for a lot more tax to be paid earlier. 

"The impact is often tens and sometimes hundreds of thousands of pounds in lifetime tax, so mistakes can be costly and – in some cases – impossible to fully fix later. Common mistakes are: planning based on one or two main drivers, such as inheritance tax, rather than overall plans. Acting on generic guidance, without taking the specifics of a family's situation into account. 

"Reducing pension contributions without properly considering associated benefits. Unplanned tax bills due to lack of flexibility in retirement funds. The message? An overall plan, including a lifetime cashflow plan, is key to making good decisions on how best to draw on pensions in retirement." 

Should you gift your pension money to your children?

Rakhee Wood, Founder & Independent Financial Adviser at Bromley-based Butterfly Financial Planning, said knee-jerk decisions should be avoided.

She added: “The biggest mistake is rushing to cash in pensions because of the inheritance tax changes. Pensions are there to fund your retirement, not simply provide an inheritance. People in their 50s and 60s should review their pensions, ISAs, property and future income needs before making decisions. 

"I often see people protecting their pensions at all costs while unnecessarily scrimping and saving. What's the point of building wealth if you're too afraid to enjoy it? Gifting isn't necessarily the answer either. Pension withdrawals can trigger income tax, and gifts may remain within your estate for seven years. 

"The key is to model different scenarios rather than make knee-jerk decisions. Don't become so preoccupied with what you'll leave behind that you forget to enjoy what you've worked so hard to build.”

Graham Nicoll, Financial Planner, Chartered FCSI at NCL Wealth Partners, said you need to be clear on what you want from retirement.

He added: “Pensions were always designed as a tax-efficient way of saving for retirement... they still provide significant value for this purpose. It is important to step back and really understand what lifestyle an individual wants to lead today, tomorrow and in retirement... and on the retirement point the question of when they want the freedom to have choices. 

"This will inform the level of income they require to support this lifestyle. Most people have no idea what this lifestyle is or the level of income they require. Once you understand this, you can figure out whether the pension is the right or only vehicle required, or more likely how you utilise ISAs, a pension or other income-producing assets such as property to support the desired lifestyle. 

"The biggest mistake is not being clear on what you want from retirement, and when... in turn not being clear on how to fund this as tax efficiently as possible. Inheritance tax on pensions is one consideration but should not be the only driver.”

Will my children pay tax twice on my pension?

Harvey Dhillon, Founder & CEO at Zmartly, said April 2027 is a significant date for pensions and inheritance tax.

He added: “The most useful thing to do now is check the form telling your scheme who you'd like to inherit your pension. From April 2027, under rules already in law, your pension won't stay out of inheritance tax just because the scheme picks who gets it. For deaths from April 2027, the spouse or civil partner exemption covers only what goes to them, and an unmarried partner isn't covered. 

"If you give money away, note what you gave, to whom, its value and when. Whether to draw down or buy an annuity is one for a regulated adviser. The mistake I'd warn against is assuming inheritance tax and income tax will hit in full. If you die in your 50s or 60s, beneficiaries usually pay no income tax on the pension. If you die at 75 or over, then from April 2027 income tax falls only on what's left after any inheritance tax they pay. The double-tax headline is oversold, but the risk from an out-of-date form isn't.”

Will my family pay inheritance tax on my pension?

Samuel Mather-Holgate, Managing Director & IFA at Swindon-based Mather and Murray Financial, urged people in their 50s and 60s to review their estate planning now.

He added: "Before anyone panics, let's remember that most families won't pay inheritance tax at all. Married couples and civil partners leaving their family home to children can potentially pass on £1 million tax-free, provided they meet the qualifying conditions. But for wealthier families, there's a nasty sting in the tail. 

"From April 2027, most unused pensions will be dragged into the inheritance tax net, potentially triggering a whopping 40% bill. Beneficiaries could then face income tax on withdrawals too, particularly where someone dies after 75. For some families, we're talking about hundreds of thousands of pounds disappearing in tax. 

“The biggest mistake is assuming your pension remains a tax-free inheritance. If you're in your 50s or 60s, review your estate planning now. Sensible gifting and pension withdrawal strategies could save your children a fortune. Don't panic and cash everything in.”