Pension inheritance: what happens to my pension when I die?

What happens to your pension when you die?

The tax rules on inheriting a pension are changing, and this could have a big impact if you have wealth tied up in your pension.

Passing on a pension is currently free from inheritance tax. But from April 2027, pension wealth you pass on when you die could be caught in the tax net.

Can my family inherit my pension?

When you die, any unspent money in your pension pot can be passed on to one or more beneficiaries of your choice.

This assumes you have a defined contribution (money purchase) pension scheme, which is the case for most workplace pensions and all private pensions.

Note that this only holds true if you have unspent pension pot remaining. This may not be the case if you have already bought an annuity.

What happens to my annuity when I die?

An annuity is a guaranteed income for life (rather than a pot of money) – and by definition, an income for life ends when your life ends. This means it can’t be passed on as such.

However, you can arrange for your partner to continue receiving an income from your annuity after your death. To do this, you’ll need to choose a ‘joint-life annuity’.

You could of course choose to spend only part of your pension pot on an annuity. In this case, the unspent portion will be inheritable as normal.

What happens to my final salary pension if I die?

If you have a defined benefit (final salary) pension, there is no pension pot to pass on.

However, the terms of your scheme may make provision for your spouse and/or other dependents such as children under the age of 23 and in full-time education, or a child who is mentally or physically impaired.

Ask your scheme administrator what will happen in the event of your death. Alternatively, some final salary schemes let you transfer out into a defined contribution pension, which you can pass on to your family.

However, a transfer may not be the best option for you, though, so ask a financial adviser.

What happens to my self-invested personal pension (SIPP) when I die?

If you have a personal pension, such as a SIPP or a stakeholder pension, this can be passed on to your beneficiaries just as a workplace (defined contribution) pension can be.

You just need to make sure you follow the necessary steps laid out below under ‘How do I choose who inherits my pension?’

What happens to my state pension when I die?

In most cases, payment of your state pension will stop completely when you die, and does not pass to your spouse.

However, there are a few circumstances in which your spouse will continue to receive a portion of your state pension after your death.

What is additional state pension?

Before the current ‘new state pension’, the state pension consisted of two parts: basic and additional.

If you reached state pension age before 6 April 2016, you may have built up some additional state pension. If you married before 6 April 2016, your spouse can inherit a portion of this when you die.

Similarly, you can inherit some of your spouse’s additional state pension if they reached state pension age before this date (or if they would have reached it on or after that date but have died).

Any inherited additional state pension is paid with the surviving spouse’s state pension.

What is a protected payment on the state pension?

Some people may have a ‘protected payment’, if they built up more state pension than the maximum amount of the new state pension before it was introduced (to avoid them losing out under the new scheme).

If your basic state pension plus additional state pension would have entitled you to more money than the new state pension alone, then this excess is your ‘protected payment’.

If you married before 6 April 2016, your spouse will inherit half of your protected payment (and vice versa).

You can estimate how much annual income you could expect in retirement using our pension calculator here.

How do I choose who can inherit my pension?

Your pension isn’t legally part of your estate, so is not covered by your Will.

You have to make arrangements with your pension provider by filling in a form – this may be called an ‘expression of wish’ form or a ‘nomination of beneficiaries’ form, or something similar.

The crucial thing is to make sure that these arrangements are kept up to date. Usually you will complete an expression of wish form when you join a pension scheme.

If you’ve had several pension schemes over your working life, then the beneficiaries you’ve nominated may be different in each case – for instance, an ex-spouse or partner, rather than your current one.

You should therefore make an effort to track down your pensions and update your wishes with each provider. It may make more sense to combine your pensions – however check with your adviser first, to make sure you don’t lose any special benefits like guaranteed annuity rates.

Also keep your will up to date. Though it doesn’t directly cover your pensions, it can help to resolve any disputes that may arise.

It will then be up to your chosen beneficiaries to contact your pension scheme provider(s) after your death, to find out how they can claim your remaining pension benefits.

How do you bequeath your pensions?

1. Keep records of your pensions and tell your family where to find them.

 2. Contact pension providers to check who is due to inherit your pension, and update the details if necessary.

 3. Keep a copy of all paperwork.

 4. Be sure to review all pensions if your relationships change.

 5. Combine your pension pots if your adviser recommends it.

Are pensions subject to inheritance tax?

The inheritance tax rules on pensions are changing. Pension pots are not currently subject to inheritance tax (IHT) when you die. However from April 2027, IHT will be charged on pension wealth you pass on to your loved ones.

These changes will mainly affect defined contribution pensions because it’s possible to have unspent money left in your pension pot when you die.

With changes to IHT pension rules, a lot more people will be paying IHT in the future. This is because the new rules will mean your pension wealth will be added to your other assets to work out the total value of your estate.

There are allowances available to reduce your tax bill, depending on your married status or who you are passing wealth to.

Here are details of the main allowances available:

• £325,000 nil rate band: The basic inheritance tax nil rate band reduces the value of your taxable estate.
• £175,000 residence nil rate band: This is an additional allowance available if you leave your home to direct descendants such as your son, daughter or grandchild, so you get an additional exemption.
• Spouse transfer: There is no tax to pay on the wealth you leave to your spouse.

If you are married and leave wealth to your spouse, you can also pass unused allowances to your spouse. This means it’s often possible to effectively double up allowances as a couple.

This means, in many cases, it’s possible to effectively leave £1 million without paying any inheritance tax.

It’s important to get tax advice and draw up a will with a legal expert who will be able to make sure you make use of all available allowances.

Are inherited pensions subject to income tax?

If you die before the age of 75, the person(s) who inherit your pension pot can draw on the money as they wish without paying income tax.

However, they don’t pay any tax up to the limit of £1,073,100, known as the lump sum and death benefit allowance (LSDBA), which recently replaced the lifetime allowance.

If you are 75 or over when you die, a beneficiary of your pension pot will have to pay income tax on any withdrawals at their marginal rate (i.e. the highest rate of income tax they pay).

If your beneficiary is entitled to continue receiving payments from an annuity or defined benefit pension after your death, these payments will be subject to income tax at their marginal rate.

Get expert financial advice

Understanding how your pension is handled after your death can help you make informed decisions about your estate and beneficiaries.

While your pension pot can be a valuable tool for passing on wealth tax-efficiently, it's crucial to ensure that your wishes are clearly documented and up to date.

Unbiased will match you with a financial adviser for expert financial advice on navigating the complexities of pension inheritance and making the most of the benefits available to you and your loved ones.