10/10/2019

10 mins

In many circumstances the answer is yes, you can inherit a pension. It’s now easier to inherit a pension thanks to the 2015 pension freedoms and the introduction of flexi-access drawdown, which is a newer, more flexible version of pension drawdown.

Pension drawdown allows an individual to move some or all of their pension into a drawdown fund, which can then be called upon later when they need it. It’s flexible and allows an individual to take as much or as little from the fund as and when they need it.

Before the pension freedoms, the tax on inherited pensions was a hefty 55%. This so-called ‘pension death tax’ received a lot of criticism and was abolished by the pension freedoms.

Today, someone inheriting a drawdown pension generally pays less tax than they would have done before April 2015 – and potentially no tax at all if the person they’re inheriting the pension from died before the age of 75.

How Can You Inherit a Pension Pot?

Given that we spend most of our working lives saving into pensions retirement, it’s no surprise that people wonder what happens to your pension when you die. This depends on the type of pension you have.

Some pensions can be inherited, including:

Defined contribution pension funds
Inheriting a pension pot, especially one in income drawdown, is perhaps the simplest way of having a pension pot passed down to you, with fewer rules than for other inheritable pensions and often retaining more of the total fund.
Joint life annuities
Based on the lives of you and your spouse, your spouse inherits joint life annuity income and continues to receive payments after your death, commonly at a percentage of the pension you were receiving in life
Annuities with guarantee periods
These pay out for a set number of years to your chosen beneficiary after your death depending on the length of the guarantee period (so an annuity with a 10 year guarantee period would continue paying out for 9 years if you died after only receiving annuity income for 1 year)

Can You Inherit a Final Salary Pension?

Final salary pension schemes are trickier to inherit.

Although a final salary scheme usually pays a survivor’s or widow’s pension to a spouse, and perhaps even dependent children aged up to around 23, this is often reduced by 50% compared to the original pensioner’s entitlement to the scheme.

There’s also tax to consider. Income from an inherited final salary pension will taxed as income at the beneficiary’s highest marginal rate.

This is partly because a defined benefit pension isn’t a pot of money you’ve saved into throughout your working life. Instead it’s a promise from your employer’s pension scheme to pay you a regular income for the rest of your life after retirement, which means who can inherit a final salary pension is governed by the scheme’s rules.

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What Happens to My Pension When I Die?

With a defined contribution pension in a drawdown arrangement, you can opt to leave your pension pot to whoever you like. The way your pension pot will be treated when you die depends largely on the age you are at your death.

A final salary or defined benefit pension, meanwhile, has a limited list of people you can leave a pension in payment to. It’s usually your spouse.

You don’t have to pay inheritance tax on pensions in most instances. This is because pensions are usually treated as being held outside your estate in trust and so aren’t added in with the rest of your assets when your estate is valued for inheritance tax purposes.

Don’t forget, if you’ve taken money out of the pension and on the date of your death you’re holding this in a vehicle that is subject to inheritance tax, such as a savings account, you may have to pay inheritance tax on these drawings.

John Spink
Head of Financial Planning at Drewberry

Do You Have to Pay Tax on Inherited Pensions?

While inheritance tax isn’t typically an issue if you leave the pension within the pension wrapper, there may be income tax to pay depending on when you pass away.

If you die before the age of 75 your beneficiaries won’t usually have to pay any tax on an inherited drawdown pension fund regardless of how they choose to take the money.

Your beneficiaries can take the money as one lump sum, continue with drawdown income or buy an annuity – all options will be tax-free providing they do so within 2 years of your death. They don’t have to reach 55, the age at which you get access to your own defined contribution pension, before they start taking it.

The 2 Year Rule

From April 6, 2016, if more than 2 years elapses between the pension provider being notified of the member’s death and the start of payments from an inherited drawdown pension fund, any payments are subject to income tax at the beneficiaries’ highest marginal rate.

If the original pensioner dies after the age of 75, there is tax to pay on an inherited pension drawdown arrangement. Your beneficiaries can still choose to take the fund as a lump sum, take flexi-access drawdown income or buy an annuity, but each option will be taxed as income at their highest marginal rate.

Can You Pass Down an Inherited Drawdown Pension?

Yes, you can pass on a pension you’ve inherited to further beneficiaries if there’s still cash left at the date of your death, providing it’s in income drawdown when you die.

A person who inherits a pension is referred to as either a dependent (e.g. spouses and children) or a nominee, used to describe someone who isn’t a dependent but has been nominated by the pension member to inherit the pension on the member’s death.

A person who inherits a pension already inherited by a dependent or nominee is usually referred to as a successor. Original pension members can’t choose successors – only nominees and dependents can.

While nominees and dependents can choose to take a lump sum death benefit from the scheme, this isn’t the case for successors. Successors have to use an inherited flexi-access drawdown pension fund to either draw an income or by an annuity.,

There’s no limit to the number of successors who can benefit from an unused pension pot in income drawdown, so you could potentially pass the cash through multiple generations in an incredibly efficient manner providing the fund lasts that long.

Jonathan Cooper
Senior Paraplanner at Drewberry

Pensions and Inheritance Tax Advice

It’s now far easier to inherit a pension than previously thanks to the introduction of flexi-access drawdown, while the pension freedoms mean that the tax on inherited pensions has been cut to as low as zero in some instances.

Drawdown pension contracts can be passed down through multiple generations and, under the new pension regime, may work out to be an incredibly tax-efficient way to pass on your wealth.

However, there are certain rules to inheriting pension drawdown arrangements that you’ll need to consider if you’re planning on passing down your pension, which is why it’s always best to check your tax position with an adviser.

For instance, if you transfer your final salary pension to a drawdown arrangement, or make significant pension contributions within 2 years of your death, or after you’ve been diagnosed with ill health, this might be considered a disposition of assets by HMRC and could attract inheritance tax when you die.

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