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What happens to my pension when I die?
One of the unique features of a pension is that it technically doesn’t belong to you; it is held by a trust for your benefit. This legal structure means that, unlike a savings account, your pension often falls outside your estate for tax purposes.
When you pay into a personal pension, your money is usually invested in stocks and shares. The value of these investments can rise or fall, so you might get back less than you put in. Returns aren’t guaranteed. Pension tax rules may also change in the future, and any tax benefits you receive will depend on your individual circumstances. Chip does not provide financial advice, if you’re unsure what pension options are right for you, speak to a regulated financial adviser.
- If you die before age 75, your pension can usually be passed on completely tax-free. If you die after age 75, your beneficiaries will be liable to pay their marginal rate of income tax on it.
- Pensions are held in a trust, meaning they are not covered by your standard last will and testament. You must fill in an ‘expression of wish’ form with your provider.
- From April 2027, pension pots will be included in your estate for Inheritance Tax calculations, removing a major historic tax benefit.
Pension death benefit rules
The tax rules for passing on a pension depend almost entirely on the age at which you die.
Before age 75
If you die before age 75, your remaining pension pot can usually be passed to your beneficiaries tax-free.
- Beneficiaries can usually choose to take the money as a single lump sum or as a flexible income stream.
- Currently they won’t pay Income Tax on the money they withdraw, regardless of earnings.
After age 75
If you die after age 75, your pension can still be passed on, but it is no longer tax-free.
- Your beneficiaries will pay Income Tax on any money they withdraw.
- This money is included in your beneficiaries earnings for the year and taxed at their marginal rate.
Pension death benefit 2 year rule
The ‘2-year rule’ states that for death benefits to be paid tax-free (when dying before 75), the pension provider must pay the funds (or designate them to a beneficiary’s drawdown account) within two years of being notified of the death.
If the provider takes longer than two years to settle the funds, the money becomes taxable even if you died before age 75.
Important to note:
- Beneficiaries should notify the provider promptly of the death to preserve the tax-free status of pots (where death was before 75).
- Tax-free lump sums are limited by the Lump Sum and Death Benefit Allowance (LSDBA) of £1,073,100. This is a limit on the total tax-free lump sums paid out across life AND death.
If a spouse, civil or cohabiting partner passes away, separate Bereavement Support Payments are available, provided the bereaved meets certain eligibility criteria.
Pension beneficiaries
Because pensions are held in a trust, the pension provider’s trustees have the final legal say on who receives the money. They are not legally bound by your Will.
Expression of wish form
An Expression of Wish (or Nomination of Beneficiaries) form is a document that tells your pension provider who you would like to receive your pension when you die.
- While the provider’s trustees ultimately have discretion, they will almost always follow your latest Expression of Wish.
- If you forget to update this form, for example, following a marriage or divorce, the trustees may pay this money to an ex-partner, as that is the last instruction they have on file.
Rules for defined contribution pensions
Defined contribution pensions (like SIPPs and workplace pots) are the easiest to pass on.
- Your remaining pot is fully inheritable.
- This money can be passed on multiple times, for example, to a spouse and then if any is left when they die, onto children.
Rules for defined benefit pensions
Defined benefit (or final salary) schemes are less flexible. Because there is no ‘pot’ of cash, you cannot usually pass a lump sum to children.
- Most schemes will pay a reduced income (often 50%) to a surviving spouse or civil partner for the rest of their life.
- Some schemes pay an income to children if they are under 18 (or 23 if in full-time education).
- Once your spouse dies and children grow up, the pension payments usually stop completely.
Changes to inheritance tax on pensions (April 2027)
Historically, pension pots have been exempt from Inheritance Tax (IHT). This made them a popular way to pass wealth to family without hitting the IHT threshold.
However, the government has announced that from April 2027, unused pension funds and death benefits will be included in the value of a deceased person’s estate for Inheritance Tax purposes.
- What’s changing? Your remaining pension savings will be added to the value of your other assets (like property and non-pension savings) when calculating if your estate owes Inheritance Tax.
- What could be owed? If your total estate, now including your pension, exceeds your tax-free allowances, the estate may be liable for Inheritance Tax at 40% on the excess.
You can find regulated and impartial advisers through the MoneyHelper website. Or, if you’re over 50 with a defined contribution pension you can get free and impartial guidance through Pension Wise.