Inheriting a pension: what happens and is there tax to pay?

With thanks to Dr Robin Keyte for sense-checking this guide.

Many pensions can be passed on – some free of tax

1. Money Purchase pensions can often be passed on

   

   The most common type of pension is the Money Purchase pension (also called defined contribution).

   Here, you add money into a pension savings 'pot', perhaps from your salary. What you end up with is directly related to what you put in – in other words, the more you save into your pot over time, the bigger the pot is when you retire.

   Most modern workplace pensions are Money Purchase pensions, as are group personal pensions and stakeholder pensions. Self-invested personal pensions (SIPPs) are a form of Money Purchase pension too, but you have far more say over where to invest your money (see our SIPPs guide for more information).

   With Money Purchase, once you're able to access the cash (currently at age 55, rising to 57 from April 2028), you can usually take it either in a lump sum, as multiple smaller payments (known as 'drawdown'), or as a combination of both.

   Regardless of whether you've started spending the money in a Money Purchase pension pot or not, any money left in the pot at the time of your death can normally be passed on – which is why it's important to fill in an 'expression of wishes' form.

   However, there is one caveat...

   Have you bought an annuity?

   An annuity is a guaranteed, regular income for life (or set period) which you can buy with the money you've saved up in your pension pot.

   With a 'single-life' annuity, this will usually stop paying out when you die, even if it hasn't paid out the equivalent of what you bought it for. So this means there's unlikely to be anything to pass on when you die.

   If you bought a 'joint life' annuity or a single/joint annuity with a 'guaranteed period', this will continue to pay out after you die to whoever else is named on the annuity. These types of annuity are generally more expensive to buy.

   It's always worth speaking to a qualified financial adviser before buying an annuity.

2. Salary Scheme pensions are more restrictive

   Salary Scheme pensions (also called defined benefit) are less common these days as they're expensive for employers to run.

   It is essentially a guarantee from your employer of a regular income while you're retired (often based on your final salary or your average salary, plus the number of years you were in the scheme). Salary Scheme pensions normally stop paying out after you die, as technically there's no 'pot' of money to leave behind.

   But, depending on the scheme, a Salary Scheme pension may continue to pay out after you die – though if it does it'll likely be at a reduced rate and only to a close dependant. In some cases, it might pay out a lump sum instead.

   If it will continue to pay out, make sure to nominate a beneficiary.

   Salary Scheme pensions vary, so if you need more information on how yours works it's best to speak with the scheme administrator and ask for the details.

   Quick questions:

   Who can a Salary Scheme pension be passed on to?

   Normally a salary scheme pension can't be passed on. If it can, it's typically limited to a close dependent, though depending on the scheme's rules you may be able to nominate someone else.

   Where a salary scheme pension can be passed to somebody who is not a close dependent, it may be taxed at 55% as an 'unauthorised payment' – it's best to check with the pension provider.

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   Can I swap a Salary Scheme pension for a Money Purchase pension?

   It's sometimes possible to swap a Salary Scheme pension for a Money Purchase pension (swap a regular income for a lump sum). Yet there are risks to giving up a Salary Scheme pension, such as forfeiting a regular income and other associated benefits.

   So if you're considering swapping your Salary Scheme pension for a Money Purchase pension – including because you want to pass on more money to a loved one – speak to a financial adviser first.

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3. Your State Pension can sometimes be boosted if your spouse / civil partner has died

   

   The State Pension works differently. What you get is based on the National Insurance contributions you make during your lifetime (especially true for those who reached state pension age on or after 6 April 2016, when the 'new' State Pension kicked in).

   But if you're married or in a civil partnership, the survivor might be able to boost their State Pension entitlement if one of you dies – though it's more likely if they reached state pension age under the old arrangements (before 6 April 2016).

   It'll depend on a number of factors, including:

   • How long they worked for. The more National Insurance contributions the deceased made, the more the survivor could boost their own State Pension.
     

   • Whether they received extra or additional State Pension / protected payment / State Pension top-up / 'graduated retirement benefit'. If the deceased was paid any of these, the survivor may be able to inherit it.

   Working out whether you're able to boost your State Pension following the death of a spouse or civil partner can be complex. There's a handy Gov.uk tool which can help work out what you may get if your spouse has died.

   If it looks like you're entitled to top up your State Pension, you can start the process by contacting the Pension Service.

   Quick question:

   What happens if I die while deferring my State Pension?

   What happens will depend on whether:

   • You reached State Pension age on or after 6 April 2016...

     ...and have delayed or stopped claiming your State Pension, your spouse or civil partner won't inherit any of the 'extra' State Pension you've built up. Instead, the beneficiaries of your estate will receive three months' backdated State Pension.
     

   • You reached State Pension age before 6 April 2016...

     ...and you die while deferring your State Pension (or are claiming your deferred State Pension when you die), your spouse or civil partner may be able to inherit part or all the extra you built up.

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4. Use an 'expression of wishes' form to nominate who you'd like to inherit your pension

   If there's someone specific you'd like to inherit your pension, then it's crucial to nominate that person in writing. If you don't, it's not guaranteed they'll inherit.

   To do this, you should fill in an 'expression of wish and nomination' form – one for each pension you've got. Do note you can't use a will to nominate who gets it.

   See our What happens to my pension when I die? guide for more on this.

   A will is still very important. While a will has little bearing on what happens to your pension, a will is still very important when it comes to determining what happens to the rest of your 'estate' when you die.

   See our Cheap and free wills guide for more information on how to write one.

5. Most people don't pay Inheritance Tax on their pension – and this won't change even after Inheritance Tax rules change in April 2027

   

   The majority of people don't pay Inheritance Tax (IHT) on a pension. This is the case under current IHT rules, and will remain so even after the rules change in 2027.

   Under current rules, while property, savings, investments and assets count towards the value of your 'estate' – the figure used to determine whether you pay IHT – the value of your pension doesn't (some exceptions to this can apply). In other words, pension savings are normally exempt from IHT.

   This is set to change from 6 April 2027, when any unspent money left in a pension pot WILL start forming part of an estate for the purpose of IHT.

   This will include any money left in a Money Purchase scheme, SIPP or drawdown fund – though importantly it won't usually include annuities and Salary Schemes (defined benefit) pensions that are already paying out (plus any unspent pension you leave to a spouse or civil partner is always exempt from Inheritance Tax).

   Yet, as we go on to explain in the next point, the number of people who pay IHT on a pension will remain very low, and the vast majority will continue to pay no IHT. And even if you do have to pay IHT, there are ways to reduce the bill...

6. Likely to pay IHT? From April 2027, your pension might be included... but there ARE things you can do to mitigate the tax bill

   

   As mentioned, most unused pension funds will start to form part of a person's estate from April 2027. One result of this is you'll no longer be able to use a pension to pass on wealth tax-efficiently.

   This means more estates will pay IHT than before – it's estimated to increase from 5% to 8%. So while the majority of estates will continue not be affected, a larger minority will be liable for IHT at 40%.

   If you are likely pay IHT, there are other things you can do to reduce the bill:

   - Spend the money in your pension

   One way to reduce a potential IHT bill is to spend your money, including anything in your pension (it is your money after all!).

   This is arguably the simplest way of IHT planning, as the money won't be in your pension (and by extension, your estate) any longer – though be mindful, the more money you take from your pension, the more income tax you'll likely pay.

   As the saying goes: no point in being the richest man in the graveyard.

   - Exchange your pension for an annuity

   Not all types of pension will start forming part of your estate after April 2027.

   Annuities – where you exchange part or all of your pension for a regular income for life – will normally remain outside the scope of IHT. So one way of reducing an IHT bill could be to exchange your pension for an annuity.

   However, you'll need to live for a decent amount of time for this to pay off (and there's no guarantee that will happen), as annuities tend to stop paying out after you die. While some annuities continue to pay out after you die, these pensions are more likely to be subject to IHT.

   Before taking out an annuity, you should seriously consider financial advice.

   - Use gifting rules to give money away during your lifetime

   Not strictly related to your pension, but gifting from your assets, savings and regular income to other people can reduce an IHT bill.

   See our Ways to legally reduce your Inheritance Tax bill guide for more info .

   - Get advice

   Our Inheritance Tax guide is a good place to start to learn the basics.

   Yet as reducing the bill can be more complex than simply spending your money or giving it away, if you're one of the few who will pay IHT then it's also probably sensible to seek specialist help from a financial adviser (if you've got enough money to pay IHT, you can probably afford tailored advice).

7. You may pay income tax on an inherited pension

   Not everyone pays income tax on an inherited pension. This means it's possible for some people to inherit a pension entirely tax-free (no IHT, no income tax).

   The general rule of thumb is:

   • You WON'T pay income tax if the pension owner died before reaching 75.

   • You WILL pay income tax if the pension owner died after reaching 75.

   This rough rule applies to Money Purchase pensions, most drawdown funds and annuities that continue to pay out after the pension owner has died – though be mindful that there are some exceptions to this rule of thumb.

   Salary Scheme pensions are more complicated. If it continues to pay out after death, income tax will be due regardless of how old the owner was when they died (unless it pays out a lump sum, in which case the 75 rule is likely to apply).

   See Gov.uk for more information on inherited pensions and income tax.

8. Any income tax will be at your own marginal rate

   If you need to pay income tax on an inherited pension, this will be at your own marginal rate (so if you're a basic-rate taxpayer you'll pay 20% in income tax).
   
   But where you're already on the threshold of a higher tax band, drawing from an inherited pension may push you into it – meaning you'll pay a higher rate of income tax on the portion of your income above the higher rate threshold.
   
   So generally speaking, a non-taxpayer will pay less income tax on an inherited pension than a basic-rate taxpayer would, while a basic-rate taxpayer will pay less than a higher-rate taxpayer, etc. You may want to take this into consideration if you're wondering who it would be most tax-efficient to pass your pension to.
   
   Use our Income tax calculator to get an idea of how much you'll need to pay.
   
   Important. Income tax will only be charged when you actually access the money, so this could be once if you take it in one lump sum, or several times if you regularly draw on the money. It'll be deducted before you receive the cash.

Pension inheritance FAQs