Making regular contributions to a pension fund allows you access to several benefits. These include tax relief and contributions from your employer, as well as a retirement income.
But your pension can even help you take care of your loved ones after you die, but keeping your savings safe and lowering the amount of inheritance tax they’ll owe.
How Does Inheritance Tax Work?
After your passing, your loved ones will have to pay pension inheritance tax1 on your estate, including on assets such as property and money. The amount of tax they owe will depend on the value to your estate and who you choose as beneficiaries.
If your assets are not valued at more than the standard inheritance tax threshold of £325,000, your beneficiaries won’t be charged. If your estate is valued at more than that, but you leave if all to your partner, spouse, or a charity, inheritance tax will be waivered.
However, if your estate has a value higher than £325,000 and you leave it to a beneficiary other than your partner or a charity, it will be taxed at 40%.
- If your estate is valued £250,000, no inheritance tax will be levied.
- If your estate is worth £500,000, but you leave it to your spouse, they won’t pay inheritance tax.
- If your estate is valued at £500,000, but you leave it to a friend, they will be charged inheritance tax of 40% on the £175,000 over the threshold.
Some inherited pension rules and exemptions could apply to your estate, so it’s best to seek advice if you’re unsure.
If you’ve requested that more than 10% of your estate be left to charity, a reduced inheritance tax rate will be applied. If you leave your house to your children or grandchildren, your inheritance threshold will rise.
Inheritance Tax on Pensions
Unlike other forms of savings, pensions are outside your estate and don’t affect your inheritance tax threshold. This makes a pension an excellent way to leave funds to your loved ones because they will lose less money to tax. There will be some conditions that apply to your pension after you die, such as your age and the type of pension you have.
Inheritance tax on defined contribution pensions
Leaving your pension to your loved ones is reasonably straight forward if you have a defined contribution pension. If you’re older than 75 and haven’t drawn from your pension pot, your beneficiaries can claim the whole fund tax-free within two years.
If you’re older than 75, your pension won’t be taxed. However, your beneficiaries will be subject to income tax.
Inheritance tax on drawdown pensions
If you pass away before you reach the age of 75, but you’ve already started accessing your pension via drawdown, your loved ones will be able to claim a lump sum from your pension fund. Alternatively, they could opt to take tax-free drawn down payments or choose to purchase an annuity.
Inheritance tax on defined benefit pensions
It can be more complicated to leave your defined benefit pension or final salary pension to your loved ones. If you pass away while you’re younger than 75 and haven’t yet retired, your beneficiary will usually get a tax-free lump sum.
If you’re older than 75, your dependent, partner or spouse will most likely receive a portion of your pension. This may be taxed.
Passing on Your Pension
If you want to leave your pension to your loved ones, you should consider following these steps:
- Set up a defined contribution pension, as this offers your beneficiaries more flexibility
- Track down any old workplace pensions and consider transferring them into one pot. Your beneficiaries will be able to access all your savings and find it easier to manage them.
- Let your pension provider know who your beneficiaries are
- Drawing up a will can help make your wishes clear and ensure your beneficiaries receive their inheritance.
A Few Common Questions
A defined-contribution plan is a pension built on contributions, made by you and your employer. The value on this pension is determined by how much you contribute to the fund. A defined benefit pension is a retirement fund in which your employer promises to pay you a predetermined amount based on your salary and length of employment.
You can receive your state pension as well as any funds you have saved privately. Your private pension is a fund you save towards in your own capacity and is independent of your state pension. Your private pension is dependent on the contributions you and your employer make, while the state pension is built on your National Insurance contribution.
While property can be a good investment, relying on it instead of a pension can be financially risky. This is because you’re dependent on the ever-changing property market. Pension plans offer a diversified investment portfolio, which lowers your investment risk. There are also various other benefits to pensions, such as tax relief programmes and employer contributions.
Your state pension can only pass to your partner or spouse when you die. If you were State Pension age before 6 April 2016, your partner could claim your Additional State Pension2. If you only reached State Pension age after 6 April 2016 and are still to receive the new State Pension, your beneficiary may be able to inherit your pension as well as an extra payment.
It’s no essential to pass your pension onto your loved ones, but it can prove an excellent way to pass on your savings to a loved one. Because pensions are subject to less inheritance tax, your family will receive more funds than if you left them other forms of savings.