Defined contribution pensions
With a defined contribution (DC) pension, including workplace pensions and SIPPs, what happens when you die depends primarily on your age at the time of death.
Death before age 75
If you die before age 75, your entire pension fund can be passed to your nominated beneficiaries completely free of income tax. This applies whether you have started taking your pension or not. Your beneficiaries can take the funds as a lump sum, transfer them into their own pension (known as a beneficiary's drawdown), or a combination of both. There is no inheritance tax on the pension fund either, as pensions normally fall outside your estate for IHT purposes.
This makes pensions one of the most tax-efficient assets you can leave to your family. Unlike ISAs, property, or other investments that may be subject to inheritance tax at 40 percent, pension funds can pass entirely tax-free if you die before 75.
Death at age 75 or over
If you die at age 75 or over, your beneficiaries can still inherit your pension fund, but any withdrawals they make will be taxed at their marginal rate of income tax. Your beneficiaries can choose to take the funds as a lump sum (taxed at their marginal rate), take regular income through beneficiary's drawdown (taxed as income), or buy an annuity (income taxed as normal).
Even though the funds are taxable after 75, pensions still offer advantages over other assets because the fund continues to grow tax-free within the pension wrapper, there is no inheritance tax on the fund, and beneficiaries can control the timing of withdrawals to manage their tax liability.
Upcoming changes to pension death benefits
The government announced in the Autumn Budget 2024 that from April 2027, unused pension funds will be brought within the scope of inheritance tax. This is a significant change that will affect pension planning strategies. Until 2027, the current rules continue to apply, but if you have substantial pension savings, it is worth seeking advice on how the proposed changes might affect your estate planning.
Defined benefit pensions
Defined benefit (final salary) pensions work differently on death. The scheme rules determine what benefits are payable, and these are less flexible than DC pensions.
Death before retirement
If you die before reaching the scheme's retirement age, most DB schemes provide a lump sum death benefit, typically a multiple of your salary (often two to four times), plus a spouse's or dependant's pension. The dependant's pension is usually a proportion of the pension you would have received, often 50 percent.
Death after retirement
If you die after you have started receiving your DB pension, the scheme will typically pay a dependant's pension to your surviving spouse or civil partner. This is usually 50 percent of your pension, though some schemes pay a higher proportion. The dependant's pension continues for the rest of your spouse's life.
Some DB schemes also offer a guarantee period, typically five or ten years, during which the full pension continues to be paid even if you die within that period. If you die within the guarantee period, the pension is paid to your estate or nominated beneficiary for the remainder of the guarantee period.
Unmarried partners may or may not qualify for a dependant's pension depending on the scheme rules. If you are in a long-term relationship but not married, check your scheme rules carefully and consider whether this affects your wider financial planning.
The state pension
The state pension cannot be inherited in the same way as a private pension. Under the new state pension (for those reaching state pension age after 6 April 2016), you may be able to inherit a protected payment if your deceased spouse or civil partner had built up entitlement above the full new state pension amount.
Under the old state pension system, you could inherit up to 50 percent of your spouse's additional state pension (SERPS). The rules are complex and depend on when both you and your spouse reached state pension age.
Nomination forms
For DC pensions, it is essential to complete and keep up to date a nomination form (also called an expression of wish or beneficiary nomination). This tells your pension provider who you want to receive your pension on your death. While the pension trustees have the final discretion on who receives the benefits, they will normally follow your nomination.
Without a valid nomination, the trustees will decide who receives the benefits, which may not align with your wishes and could cause delays. Key points to remember about nominations:
- Review your nominations whenever your personal circumstances change, such as marriage, divorce, or the birth of a child
- You can nominate anyone, not just family members
- You can split the benefit between multiple nominees in whatever proportions you choose
- Nominations are not automatically updated by marriage or divorce
- Each pension provider needs its own nomination form
Pensions and inheritance tax planning
Under current rules (until April 2027), pensions are one of the most effective inheritance tax planning tools available. Because pension funds normally fall outside your estate for IHT purposes, spending other assets first and preserving your pension pot can significantly reduce your estate's IHT liability.
For example, if you have a pension pot and ISA savings, using your ISA savings for retirement income and leaving your pension untouched means the pension passes outside your estate while the ISA savings (which would have been subject to IHT at 40 percent) have been spent. This strategy needs to be balanced against your own income needs and the proposed changes taking effect from April 2027.
Getting advice
Pension death benefits interact with inheritance tax, income tax, and estate planning in complex ways. A pension adviser can help you understand how your pension fits into your broader estate plan, ensure your nominations are up to date, and advise on strategies to maximise the value passed to your beneficiaries. This is particularly important given the proposed changes to pension taxation on death from 2027.
The bottom line
Your pension can be one of the most valuable assets you leave behind, potentially passing to your beneficiaries completely free of tax. Understanding the death benefit rules, keeping your nomination forms up to date, and planning your retirement withdrawals with inheritance in mind can make a significant difference to what your family receives. With changes on the horizon, now is a good time to review your pension planning with a qualified adviser.