What happens to your pension when you die?
Unlike many other assets, pensions do not automatically form part of your estate when you die. This gives them a unique and valuable position in financial and estate planning. What happens to your pension depends on the type of scheme, your age at death, whether you have started drawing benefits, and who you have nominated as your beneficiary.
Understanding these rules is essential because, with proper planning, pensions can be passed on to your loved ones either completely tax-free or at a favourable tax rate — making them one of the most efficient vehicles for passing on wealth.
Death benefits from defined contribution pensions
Defined contribution (DC) pensions, including personal pensions, SIPPs, and workplace money purchase schemes, offer the most flexible death benefits. The rules depend on your age at death:
- Death before age 75: The entire pension fund can be paid to your nominated beneficiaries completely tax-free, whether taken as a lump sum, drawdown income, or used to purchase an annuity. This applies whether or not you had started drawing benefits
- Death at age 75 or over: Beneficiaries can still receive the pension fund as a lump sum, drawdown income, or annuity, but payments are taxed at the recipient's marginal income tax rate. A lump sum would be taxed as income in the year of receipt, while drawdown allows the beneficiary to spread the tax over multiple years
The pension fund does not go through probate and is not subject to inheritance tax (in most cases), making it remarkably tax-efficient for wealth transfer. This is why financial planners often recommend spending other assets first in retirement and preserving pension wealth as long as possible.
💡 Completing a nomination of beneficiaries form (also called an expression of wish) with your pension provider is critical. While pension trustees have the final discretion over who receives the death benefits, they will almost always follow a clearly expressed and up-to-date nomination. Review and update this form after major life events such as marriage, divorce, or the birth of children.
Death benefits from defined benefit pensions
Defined benefit (DB) pensions, including final salary and career average schemes, typically offer more limited but still valuable death benefits:
- Spouse's or partner's pension: Most DB schemes pay a percentage (usually 50% or 33%) of the member's pension to a surviving spouse or registered civil partner for the rest of their life. Some schemes extend this to unmarried partners, but not all
- Dependant's pension: Qualifying dependent children (usually under 18, or under 23 if in full-time education) may receive a pension, typically a percentage of the spouse's pension
- Lump sum death benefit: If you die before retirement, many DB schemes pay a lump sum of two to four times your salary to your nominated beneficiaries
- Guaranteed period: If you die shortly after starting to draw your pension, some schemes guarantee payments for a minimum period (often five or ten years), with the balance of the guarantee period paid to your beneficiaries
Nomination forms and expressions of wish
For defined contribution pensions, the pension trustees have discretion over who receives the death benefits, guided by your nomination form. This discretionary structure is what keeps the pension outside your estate for inheritance tax purposes. If the trustees were legally bound by your nomination, the pension would become part of your estate.
Your nomination form should name your preferred beneficiaries and, ideally, the proportion each should receive. Keep it updated — a common issue arises when a divorced person has not updated their nomination, and the ex-spouse is still named as the primary beneficiary. While trustees can override an outdated nomination, this causes delays and potential disputes.
⚠️ If you have a defined benefit pension and are not married, check whether your scheme pays a partner's pension to unmarried partners. Many older DB schemes only recognise spouses and civil partners. If your partner would not qualify, you may need to arrange additional life insurance to protect them.
Pensions and inheritance tax
Under current rules, most pension death benefits fall outside the deceased's estate for inheritance tax purposes. This makes pensions an exceptionally tax-efficient way to pass on wealth. However, 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 significant change means that estate planning involving pensions will need to be revisited. The details of how IHT will interact with pension death benefits are still being finalised, and professional advice will be essential to understand the implications for your specific situation.
Beneficiary drawdown: inheriting a pension
When a beneficiary inherits a defined contribution pension, they can typically choose to take the funds as a lump sum, move them into beneficiary drawdown (taking income as and when they need it), or purchase an annuity. Beneficiary drawdown is often the most flexible and tax-efficient option, allowing the inherited pension to remain invested and be drawn down over time.
A key benefit of beneficiary drawdown is that the inherited pension can continue to be passed on. If the beneficiary dies before exhausting the fund, it can pass to their own nominated beneficiaries, potentially remaining outside the estate for IHT purposes (under current rules). This cascade of tax-efficient wealth transfer is one reason pensions are increasingly used as estate planning tools.
Get expert help with pension death benefits
Understanding and optimising pension death benefits requires knowledge of pension regulations, tax rules, and estate planning. A qualified pension adviser can help you ensure your nominations are up to date, your benefits are structured tax-efficiently, and your loved ones will receive the maximum possible benefit.
Nesto connects you with FCA-regulated pension advisers who can help you navigate pension death benefits and integrate them into your broader estate plan. Get free, no-obligation advice today.