Can You Inherit a Pension?

In the UK, pensions are a crucial aspect of financial planning for retirement, providing individuals with a stable income after they stop working. Many people ask what happens to a pension when someone passes away, this article explores whether you can inherit a pension, how the process works, the tax implications, and other key considerations for beneficiaries.

What Happens to a Pension When Someone Dies?

When an individual with a pension plan dies, what happens to their pension depends on the type of pension they have. There are generally two types of pensions: defined benefit and defined contribution.

1. Defined Benefit Pension

A defined benefit pension (often referred to as a final salary or career average pension) pays out a guaranteed income to the pension holder in retirement, based on their salary and length of service. Upon the pension holder’s death, the defined benefit pension may offer benefits to a surviving spouse, civil partner, or dependents. These benefits typically take the form of a reduced pension income or a lump sum payment.

Survivor’s Pension: The surviving spouse, civil partner, or dependent may receive a percentage of the original pension holder’s pension income. The exact percentage varies depending on the scheme but is often around 50% to 66% of the pension.
Lump Sum Payment: If the pension holder dies before starting to receive their pension, some schemes offer a lump sum payment to their beneficiaries. This amount can vary depending on the terms of the pension scheme.

2. Defined Contribution Pension

A defined contribution pension (such as a personal pension, stakeholder pension, or a workplace pension) depends on the contributions made by the pension holder and the investment growth of those contributions. The pension pot accumulates over time, and upon the pension holder’s death, the remaining funds in the pension pot can be passed on to beneficiaries.

Nomination of Beneficiaries: The pension holder can nominate one or more beneficiaries to inherit their pension. The pension provider will usually follow the wishes of the pension holder, but they may have some discretion depending on the pension scheme’s rules.
Inheritance Options: The beneficiaries of a defined contribution pension typically have several options:
- Lump Sum: The entire pension pot can be paid out as a lump sum.
- Income Drawdown: The beneficiaries can choose to leave the money invested and withdraw income as needed.
- Annuity Purchase: The beneficiaries can use the pension pot to purchase an annuity, providing them with a regular income for life.

Tax Implications of Inheriting a Pension

The tax treatment of inherited pensions depends on the age of the pension holder at the time of their death.

1. Death Before Age 75

If the pension holder dies before reaching the age of 75, the beneficiaries can inherit the pension without paying any income tax. This tax-free status applies whether the beneficiaries take the pension as a lump sum, income drawdown, or annuity.

2. Death After Age 75

If the pension holder dies at the age of 75 or older, the inherited pension is subject to income tax. The beneficiaries will pay income tax at their marginal rate on any withdrawals they make from the pension. This applies whether they choose to take a lump sum, income drawdown, or annuity.

Is Inheritance Tax Payable on Pensions?

Pensions are generally not subject to Inheritance Tax (IHT) because they are usually held outside of the pension holder’s estate. However, there are exceptions:

Lump Sum Payments from Defined Benefit Pensions: In some cases, lump sum death benefits from a defined benefit pension may be subject to IHT if they are paid into the pension holder’s estate rather than directly to the beneficiaries.
Nomination of Beneficiaries: If the pension holder has not nominated beneficiaries, the pension provider may pay the death benefits into the estate, making them potentially subject to IHT.

What Should Pension Holders Do to Ensure Their Pension Passes to Their Loved Ones?

To ensure that a pension passes to the intended beneficiaries, pension holders should take the following steps:

Nominate Beneficiaries: Most pension providers allow pension holders to nominate one or more beneficiaries to inherit their pension. This can usually be done by completing a simple form with the pension provider. It is important to keep the nomination up to date, especially after significant life events such as marriage, divorce, or the birth of children.
Review Pension Arrangements: Pension holders should regularly review their pension arrangements and discuss their wishes with their beneficiaries. This helps to ensure that their pension will be managed according to their wishes after they die.
Consider Professional Advice: Pension rules can be complex, and the tax implications of inheriting a pension can vary depending on individual circumstances. Pension holders may benefit from seeking professional financial advice to ensure that their pension is passed on in the most tax-efficient way.

Conclusion

Inheriting a pension in the UK is possible, but the process and tax implications depend on the type of pension and the age of the pension holder at the time of their death. Defined contribution pensions offer more flexibility for beneficiaries, while defined benefit pensions may provide a survivor’s pension or lump sum. It is crucial for pension holders to nominate beneficiaries and regularly review their pension arrangements to ensure their wishes are followed. While pensions are generally not subject to Inheritance Tax, certain circumstances can result in tax liabilities, making it essential to seek professional advice.

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