Passing on your pension when you die
Your pension can be a valuable part of inheritance-tax planning, says David Prosser.
Pensions can be a valuable part of inheritance-tax planning.
Most pensions have an unusual status under the inheritance tax (IHT) rules. They don't count towards the total amount you are allowed to pass on to heirs without any tax being due. For this reason, defined-contribution (DC) pensions (where benefits are uncertain and depend on asset-price performance) are a valuable IHT planning tool; income from a final-salary pension or an annuity, by contrast, usually dies with you or your spouse.
The bottom line is that savings you have invested in a DC pension plan can be bequeathed to anyone you choose. Importantly, you do this by completing an "expression of wishes" with your pension provider rather than through your will.
It doesn't matter whether you've started taking money from your savings using an income-drawdown plan or whether you're still building up your fund. Either way, the money won't be considered part of your estate for inheritance-tax purposes.
Your beneficiaries may still have to pay some tax. Usually, if you die before the age of 75, your pension savings can be passed on completely tax-free; your beneficiaries can use the money however they wish with no tax to pay as long as they take it within two years.
By contrast, if you die aged 75 or over, your beneficiaries normally pay income tax on what they receive at their highest marginal rate of income tax. The way the system is set up has some important implications for IHT planning. It makes sense, from an IHT point of view, to run down savings such as money in an individual savings account (Isa) before you start using your pension money. Almost all other forms of savings do count towards your estate, so reducing them and leaving your pension in place could be a way to reduce the IHT bill.
You should also discuss tax planning with your heirs. If you're passing on pension savings after your 75th birthday, they may need to think carefully about how to take the money in order to manage their income-tax bill. It may not make sense to take it all in one go. By contrast, non-taxpayers will pay nothing on inherited pension savings, even from someone over the age of 75. You could take advantage of this by leaving money to grandchildren, for help with university costs or a house deposit, for instance.