If asked what your most significant assets are, you may list property, shares, cars, and other investments. You might not immediately think to include your pension.
And yet, your pension could be one of your most valuable assets.
According to IFA Magazine, the average UK pension pot for people aged 60 to 69 is £223,441, and of course, many people may have accrued a much larger retirement fund.
However, research published by Canada Life shows that almost half of UK adults haven’t thought about who should inherit their pension.
Have you? Perhaps you weren’t even aware this was an option. Maybe it’s on your to-do list but keeps getting bumped in favour of “more important” or “more urgent” tasks.
Whatever the reason, if you don’t currently have a plan for passing on your pension to loved ones, read on to discover how inheritance works for different types of pension schemes, and learn a couple of practical steps for ensuring that your loved ones benefit from your savings.
How inheritance works depends on which type of pension pot you have
The way your beneficiaries can inherit your pension funds and how much (if any) tax they’ll pay depends on the type of scheme you belong to.
Defined contribution pension
A defined contribution (DC) or “money purchase” scheme could be a workplace pension or a private pension you’ve set up independently. The amount in your pot is determined by how much is paid in by you, your employer, or any third party, plus tax relief and any investment returns generated.
You can nominate anyone you like to receive any remaining funds in your DC fund when you die.
There are two key factors that might affect how your beneficiaries inherit your DC pension:
- Your age when you die
- Whether you’ve already started drawing your pension.
There’s usually no Inheritance Tax (IHT) to pay when your beneficiaries inherit your DC pension.
Meanwhile, if you die before you turn 75 and you haven’t started drawing your pension, it can be passed to your beneficiaries tax-free – provided a claim is made within two years. However, the Lump Sum and Death Benefit Allowance (LSDBA) limits the total amount of tax-free lump sums that can be paid to your beneficiaries to £1,073,100 (2024/25), before they might face Income Tax at their marginal rate.
If you die after your 75th birthday, your beneficiaries will usually need to pay Income Tax at their marginal rate on any pension funds you leave behind.
Likewise, if you’ve taken a lump sum from your pension, any funds remaining from this withdrawal are likely to be considered part of your estate for IHT purposes, so your beneficiaries could face a tax bill. In contrast, if you’ve opted for drawdown, your beneficiaries may be able to access your remaining funds without incurring any IHT.
Defined benefit pension
If you have a defined benefit (DB) pension through an employer, you will receive a secure income for life. The amount you’re paid is calculated based on how long you were a member of the scheme and your salary – often either your final salary when you left or retired, or a career average over the time spent with your employer.
You can’t pass on a DB pension in the same way as a DC pension. Still, if you die after you’ve retired, your provider will usually continue making payments – albeit at a reduced rate – to your spouse, civil partner or other dependant.
If you die before you retire, a DB pension scheme may pay out a lump sum to your beneficiaries. If you die before the age of 75, this payment is usually tax-free. Whereas, a later death could result in an Income Tax bill for your spouse, partner, or dependant.
The State Pension
You can only pass on your State Pension to your spouse or civil partner.
How much your beneficiary will receive depends on whether you reached the State Pension Age before or after 6 April 2016, when the new State Pension came into effect.
As you can see from the above, pension and tax rules can be complex, so you might benefit from consulting a financial planner who can help you review your pensionable assets and decide how to pass them on.
How to make sure your loved ones benefit from your pension
There are a couple of practical steps you could take to ensure that your pension savings are passed on in line with your wishes.
Complete an “expression of wish” form and keep it up to date
You may be surprised to learn that a will does not automatically determine who receives your pension.
To ensure your savings are passed on to your intended beneficiaries, you need to complete an “expression of wish” form with your pension provider. This tells them who you want to receive your pension savings after you’re gone.
Worryingly, MoneyAge has revealed that more than 72% of UK adults have failed to complete an expression of wish form.
If you do not leave an expression of wish form when you die, the rules dictate that your pension pot is passed to your “financial dependants”. This could mean that your funds are paid to unintended beneficiaries.
Equally, if your circumstances have changed – perhaps you’ve married or divorced – and you haven’t updated your expression of wish form, your pension may not be distributed in line with your current wishes.
Filling out the form is relatively straightforward and could ensure that your loved ones enjoy the tax-efficient benefits of inheriting some of your wealth.
What’s more, having an accurate and up-to-date form could help the trustees of your pension scheme pay out swiftly and efficiently, without your loved ones having to face the hassle and stress of fighting for their inheritance.
Keep key pension rules in mind
The amount of tax your loved ones may need to pay on your pension savings depends on your unique circumstances and that of your beneficiaries, including:
- How old you are when you die
- Whether you’ve received a serious ill-health lump sum
- The amount of money you’ve taken from your pension as tax-free withdrawals
- Whether you have Lifetime Allowance protection or “enhancements”.
A financial planner can help ensure that your savings are passed on in line with your wishes and as tax-efficiently as possible.
Get in touch
If you’d like to know more about how to pass on your pension to your loved ones, we can help.
Please contact us by email at info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can help you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pension Regulator.
The Financial Conduct Authority does not regulate estate planning.
Production
