Millions of pension savers risk losing thousands of pounds to tax unnecessarily as confusion over retirement income options leaves many vulnerable to costly mistakes.
Just 42% of adults say they have a clear understanding of the options available when taking money from their pension. Even among those aged over 55, the figure rises only slightly to 45%, according to the research by investment experts Hargreaves Lansdown. The warning comes as pension wealth is set to become far more exposed to inheritance tax (IHT) under planned rule changes from April 2027.
Financial experts say a lack of understanding about how pensions work could not only result in retirees paying unnecessary income tax, but also leave families facing inheritance tax bills running into thousands of pounds. Under current rules, any money left inside a pension when someone dies is generally exempt from inheritance tax.
However, from April 2027, unused pension funds are due to be brought into estates for IHT purposes, potentially exposing families to a 40% tax charge on part of their inheritance.
For a pension pot worth £100,000, that could mean an inheritance tax bill of up to £40,000 in some circumstances. Even a relatively modest pension fund of £7,500 could generate a £3,000 tax charge if fully exposed to the 40% rate.
The findings were highlighted by consumer expert at Which? Money, who warned that many people are still unclear about the retirement choices available to them.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “This can lead to not having enough income, potentially running out of money, or incurring huge tax bills that needn’t have happened. All can have a huge impact on your standard of living, and all are avoidable.”
Three main ways to access a pension
Retirees with defined contribution pensions can normally access their savings from age 55, rising to 57 from 2028.
Most people can take up to 25% of their pension tax-free, subject to a maximum tax-free amount of £268,275 across all pensions.
The main options are:
- Pension drawdown – allowing savers to keep their pension invested while taking income as needed.
- Annuities – exchanging pension savings for a guaranteed income for life.
- Lump sums – taking money directly from an uncrystallised pension pot, with 25% tax-free and the remainder subject to income tax.
Experts warn that withdrawing too much too early can increase the risk of running out of money later in retirement, while taking large lump sums in one go can trigger unexpectedly high tax bills.
Inheritance tax changes loom
The inheritance tax implications of pension planning are becoming increasingly important ahead of the April 2027 reforms announced in Rachel Reeves‘s Budget. Currently, pensions are widely used as an estate-planning tool because they can usually be passed on outside the inheritance tax net.
Once the new rules take effect, many families may need to rethink how they structure their retirement savings and inheritance plans. Which? said pension savers should carefully consider their options and seek guidance before making irreversible decisions.
People aged over 50 can access free guidance through the Government-backed Pension Wise service, while those with larger pension pots may benefit from regulated financial advice.
