Passing on your pension when you die

Your pension can be a valuable part of inheritance-tax planning, says David Prosser.

939_MW_P29_pensions
Grandchildren don't pay tax on inherited pensions

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.

Recommended

Pass on your pension without paying inheritance tax
Personal finance

Pass on your pension without paying inheritance tax

The 2015 pension reforms make it easier for you to ensure your heirs avoid inheritance tax when you die
29 Jan 2020
What are the best ways of raising more money in tax?
Economy

What are the best ways of raising more money in tax?

Given that whoever wins next week's election will be going on a massive spending spree, we're going to need to raise at least some of that money throu…
5 Dec 2019
What are the biggest mistakes investors make when it comes to tax?
Investment strategy

What are the biggest mistakes investors make when it comes to tax?

The tax implications of an investment are something we rarely consider until after the event. That could prove to be an expensive mistake, says Domini…
27 Nov 2019
Pensions drawdown: don't take too much money out of your pension fund
Pensions

Pensions drawdown: don't take too much money out of your pension fund

New evidence suggests people are depleting their pensions too quickly – and they risk running out of cash in retirement.
14 Oct 2020

Most Popular

The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020
Negative interest rates and the end of free bank accounts
Bank accounts

Negative interest rates and the end of free bank accounts

Negative interest rates are likely to mean the introduction of fees for current accounts and other banking products. But that might make the UK bankin…
19 Oct 2020
What would negative interest rates mean for your money?
UK Economy

What would negative interest rates mean for your money?

There has been much talk of the Bank of England introducing negative interest rates. John Stepek explains why they might do that, and what it would me…
15 Oct 2020