For many people, pensions are simply a way to save for retirement. However, they can also play an important role in passing wealth to your loved ones in a tax-efficient way.
Understanding how pension death benefits work could make a significant difference to what your family receives in the future. Many people are surprised by just how valuable pensions can be when it comes to estate planning.
Why age 75 matters?
How your pension is taxed when it passes to your beneficiaries largely depends on your age when you pass away.
If you die before the age of 75, your defined contribution pension can usually be passed to your chosen beneficiaries free of Income Tax. They may be able to receive the benefits as a lump sum, keep the pension invested or draw an income, depending on the scheme's rules.
If you die aged 75 or over, your beneficiaries can still inherit your pension, but any withdrawals they make will normally be taxed as income at their marginal rate of Income Tax.
Why this matters for planning?
Here's what makes pensions unusual. They have traditionally sat outside your estate for Inheritance Tax purposes. Unlike your home, your savings accounts or your investments, your pension pot has not normally counted towards the value of your estate.
That means if you have other assets you can rely on in retirement, such as ISAs, rental income or other savings, leaving your pension untouched, or drawing from it last, has often been a very effective way to pass wealth to your family in a tax-efficient way.
Consider someone with a £500,000 pension and £500,000 in ISAs and savings. If they spend down their ISAs first and leave their pension intact, more of their wealth may be passed to their beneficiaries in a tax-efficient way.
Who gets your pension?
Your pension provider will usually ask you to complete an Expression of Wish, sometimes called a nomination form, naming who you'd like to receive your pension when you die. This isn't legally binding in the same way as a Will, as the scheme trustees or provider have the final say. However, in practice, they will usually follow your wishes.
It's important to keep this up to date. If your circumstances have changed, perhaps following a divorce, a new relationship, or the arrival of children or grandchildren, an outdated nomination could mean your pension goes to someone you didn't intend.
Why are Defined Benefit pensions different?
If you have a final salary or defined benefit pension, the rules are different. These schemes typically pay a reduced pension to a surviving spouse or civil partner, often around 50% of your pension. They don't usually offer a lump sum death benefit in the same way, and the options for other beneficiaries are more limited.
If you have both types of pension, it's worth understanding how each one works so you can plan accordingly.
The rules are changing
The government has announced plans to bring most unused pension funds into the scope of Inheritance Tax from April 2027, although the legislation is still progressing and the final rules may change.
As a result, it's important to review your pension and estate planning regularly to ensure it continues to reflect your circumstances and objectives.
What should you do next?
If you haven't reviewed your pension nominations recently, or you're not sure how your pension fits into your wider estate plan, now is a good time to take a closer look.
We'd be happy to help you understand the death benefit options available on your pensions, make sure your nominations are up to date, and look at how your pension fits alongside your other assets in the most tax-efficient way.
If you'd like to discuss your pensions or your wider financial plan, get in touch to arrange an initial consultation with one of our advisers.
Important Information
This information is for general guidance only and does not constitute personal financial advice. You should seek professional advice tailored to your individual circumstances before making any financial decisions.
Pensions are designed to help fund retirement, so money can’t usually be taken out again until at least 55 (rising to 57 from April 2028). Pension and tax rules may change, and benefits depend on your individual circumstances.
Tax treatment depends on individual circumstances and may be subject to change in the future. HM Revenue and Customs practice and the law relating to taxation are complex. The Financial Conduct Authority does not regulate tax planning.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. The Financial Conduct Authority does not regulate inheritance tax planning.
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