How to stay in control of retirement income as pension tax rules change

Retirement has always involved difficult financial decisions, but the challenge is becoming more complex. Many people now reach retirement with a mix of workplace pensions, personal pensions such as SIPPs, ISAs, investments and cash savings. The question is no longer simply how much income to take, but where to take it from.

This challenge, known as “decumulation”, has been described as one of the hardest problems in finance. The aim is to create an income that lasts throughout retirement while remaining flexible enough to respond to changing circumstances, tax rules and family needs.

A changing retirement landscape

Several developments have reshaped retirement planning. The new State Pension simplified one part of the landscape, while the growth of defined contribution pensions means fewer people have the certainty of a defined benefit income. Pension freedoms have also given retirees much greater choice over how and when they access their savings.

Retirees must also plan against uncertain life expectancy, frozen tax allowances and changes to capital gains and dividend taxes. At the same time, many want to leave money to their family rather than spend everything during their lifetime.

Why the inheritance tax change matters

Perhaps the most significant upcoming change concerns inheritance tax (IHT). At present, unused pension funds generally sit outside an individual’s estate for IHT purposes. This has encouraged some retirees to preserve their pensions, spend other assets first and use pension wealth to pass money to future generations. From 6 April 2027, most unused pension funds and pension death benefits will be included when calculating the value of an estate for inheritance tax.

This means IHT could be payable on pension funds, reducing the amount that can be inherited by family members. It could also mean that estates that were previously below the IHT threshold become liable for IHT once pension funds are included in the estate.

And some families might have to pay income tax as well as IHT on their inherited pension fund. If the pension holder dies before age 75, many inherited pension payments can usually be taken free of income tax, subject to the relevant rules and allowances. If they die at 75 or over, withdrawals are generally taxed at the beneficiary’s marginal rate.

Should you spend your pension first?

It may be tempting to conclude that pensions should simply be spent before other assets, but retirement planning is rarely that straightforward. The right approach depends on personal circumstances and the tax consequences of taking money now.

For example, taking larger pension withdrawals could push someone into a higher income tax band. Leaving the money invested may still be more tax-efficient, particularly if it is likely to pass to a spouse or civil partner, where inheritance tax exemptions should apply.

The beneficiary’s own position matters too. A younger family member with little income could pay less tax than someone already paying higher-rate tax. Retirement planning therefore needs to consider not only the retiree’s tax position, but also who may eventually inherit the assets.

Think across all your assets

The changes highlight the danger of treating retirement savings as separate pots—for example, spending cash first, then ISAs and finally pensions. A rigid order may not produce the best outcome. Instead, retirees may benefit from viewing all their assets as part of one financial plan. That could mean drawing smaller amounts from several sources each year. Or if you use an ISA to hold some high-risk investments, on top of our ‘safer’ retirement savings, instead of spending that money first, change the investments held rather than using up the wrapper itself.

The goal should be long-term tax efficiency across an entire retirement, rather than minimising tax in a single year. Retirement can last for decades, and tax rules, spending needs, health and family circumstances can all change over that time.

Flexibility is key

There is no universal formula. The best strategy will depend on age, health, income, family circumstances, investment choices and inheritance goals.

What is clear is that retirement income plans should be reviewed regularly. Pensions can no longer automatically be assumed to be the last asset to spend. A flexible, joined-up approach can help retirees make their money last, manage tax across their lifetime and preserve options for the people they hope to support.