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You’ve spent decades saving into your pension and, hopefully, have a decent pot set aside to see you through retirement. But what happens to your pot when you die?
In this article, we’re focusing on defined contribution pensions – like stakeholder pensions, SIPPs or any workplace pension where there isn’t a guaranteed return. If you have a defined benefit pension, read what happens to a final salary pension when you die. If you’re not sure which you have, read our article on the difference between defined contribution and defined benefit pensions.
We’ll explain who inherits your pot, the tax situation, and how can you make sure the money goes to the right person.
What’s on this page?
It’s up to you who inherits your pension when you die. You can leave it to a spouse or partner, your children, other family members or friends. You can also pass on money to your favourite charities.
At the moment, your pension usually isn’t legally part of your estate, so won’t be covered by your will. Who gets your pension when you die will depend on who you’ve named on your ‘expression of wishes’ or ‘nomination of beneficiaries’ forms. These are not legally binding, but will generally be followed. (The fact that the pension trustees have some discretion is what allows the pension to fall outside of your estate for IHT purposes.)
You normally complete these forms when you open your pension, but you can update your instructions at any point.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: “It’s absolutely vital that you keep expression of wishes forms up to date so administrators can bear your wishes in mind.
“Updating these forms for all your pensions after key life events such as marriage, divorce or the birth of a child is really important to make sure the right person gets the money.”
If you don’t nominate any pension beneficiaries, your pension provider will usually make enquiries and decide who should inherit your pension. While they have a duty of care to ensure the money is distributed fairly, they won’t be able to take your personal wishes into account.
A Nest pension works slightly differently. That’s the government-backed pension scheme that many employers have signed up to, with 13 million members.
With Nest, if you complete an expression of wish, which isn’t binding on the pension trustees, your pension isn’t part of your estate. But if you complete a nomination, which is binding, then your pension will automatically become part of your estate. It will also become part of your estate if you don’t complete an expression of wish or nomination.
From April 2027, whatever your provider, your pension will be included in your estate for inheritance tax purposes. It’s not currently thought that you'll need to include it in your will, although this could still change.
Generally, your beneficiaries could choose to take all the money as a lump sum, purchase an annuity for a guaranteed income or move the money into pension drawdown and make withdrawals over time.
The exception is if you’ve already used your pension to buy an annuity, In that case, what they’ll get depends on the choices you made when you selected your policy.
A joint-life annuity will continue to pay an income to the second person named on the policy. If you purchased an annuity with a guarantee period and are still within it, they will get the income. Some policies also offer ‘value protection’, which pays out a lump sum on death.
But if you bought a single-life annuity without any guarantees or protection, your beneficiaries would receive nothing – the income ends when you do.
Ian Futcher, a financial planner at Quilter, says: “Defined contribution pensions remain one of the most inheritance-tax-efficient ways to pass on wealth, but only for now.
“When someone dies with money left in their pension, it typically falls outside their estate for inheritance tax purposes. And if death occurs before age 75, beneficiaries can usually access the funds entirely tax-free.”
The rules are complex, though.
If you die before you turn 75, then whoever inherits your defined contribution pension can access the money without paying income tax. But only up to a limit of £1,073,100 – the lump sum and death benefit allowance (LSDBA), which limits the amount that can be taken out of a pension as a tax-free lump sum. Anything above that will be subject to income tax.
Susan Waites, a partner at Hymans, says: “If a lump sum would exceed the available LSDBA, an alternative might be for it to be taken instead as beneficiary drawdown which would be tax-free.
“This is because paying death benefit as beneficiary drawdown is not a lump sum benefit, so it is not tested against the LSDBA.”
And timing matters. Your beneficiaries will usually need to claim your pension within two years, otherwise income tax will likely be payable, even if you died before turning 75. This means it’s a good idea to let your loved ones know about your pension and how to claim it.
The tax rules are different if you are 75 or over when you die. Any money taken from the pension will be taxed as income at your beneficiary’s tax rate. This means they will need to consider the size and frequency of their withdrawals, to ensure they don’t pay more tax than necessary.
While you don’t currently need to pay IHT on pensions, from April 2027, unused pension funds will be included in your estate for inheritance tax purposes. That means that if your total estate is over IHT allowances, your pension could be taxed at 40%. And if you die over 75 and your beneficiary is an income taxpayer, they may then pay income tax on any money they take from it, “creating a potential double tax hit,” says Futcher.
As pensions are not currently counted as part of your estate, the money can usually be passed on quite quickly, in a matter of weeks.
The rule that pensions can’t be accessed until you’re 55 doesn’t apply if you inherit a pension. Beneficiaries will be able to access the money immediately, whatever their age.
If a beneficiary is under 18, the funds will be held in trust until their 18th birthday. The trustees can use the money to provide an income for the child, who will gain full control of the money when they turn 18.
Defined contribution pensions are currently one of the most tax-efficient ways to pass on wealth, but that may change from 2027.
In the meantime, you need to ensure the right person inherits and, preferably, without a hefty tax bill. Keep your expression of wishes form up to date and let your family know where your pensions are held.
Taking the time to understand how the process works and who will inherit could save your loved ones an unnecessary tax bill and stress at a difficult time.
If you’re concerned that the impending changes around IHT and pensions will affect you, it’s worth speaking to a legal adviser who can help you with estate planning.
Find out the different types, the pros and cons, and how much income you might get.
Find out the pros and cons, and what it could mean for your income and tax bill.
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