Are pension savings subject to Inheritance Tax? The rules explained

Inheritance: Expert gives advice on ‘good planning’

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PLANNING for inheritance can be uncomfortable as it involves confronting one’s mortality, but it’s important financially to understand how funds will be affected upon ones death.

Naturally, the taxman will be after his slice of any funds but if people are proactive and take early measures, they can ensure that their inheritance passes as cleanly as possible.

There are two types of private pensions: Defined Benefit pots (DBs) and Defined Contribution pots (DCs).

Money Helper, which was set up ad sponsored by the Department for Work and Pensions (DWP), said: It’s important to understand what will happen to your pension when you die, and what the tax implications will be of passing on your pension.

“How your workplace pension or one you’ve set up yourself might be paid to your beneficiaries when you die depends on what type of pension you have.”

Inheritance tax and pensions

The inheritance tax that may be paid on a pension depends on what kind it is (Image: Getty)

Defined Benefit

A DB pot pays people a retirement income based on how long they worked for their employer and what their salary was.

They include what is called a ‘final salary’ or ‘career average’ schemes.

These are mostly only available to public sector workers or older workplace pension schemes.

If someone dies while an active member of the DC scheme, the person’s beneficiaries might get a lump sum payment, which will be paid tax-free if the person died before their 75th birthday.

As for other scenarios, each scheme will have different rules governing what beneficiaries are entitled to inherit.

The Government said: “A pension from a defined benefit pot can usually only be paid to a dependant of the person who died, for example a husband, wife, civil partner or child under 23.

“It can sometimes be paid to someone else if the pension scheme’s rules allow it – but it will be taxed at up to 55% as an unauthorised payment.”

In this case, the amount they receive will be subject to taxation as if it were normal income.

Defined Contribution

A DC scheme allows people to build up a pension pot whereby both the individual and their employer will make minimum contributions.

The minimum contribution is eight percent of salary, five percent of which is paid by the employee and three percent by the business, although some workplaces may be more generous and individuals are free(indeed, incentivised) to contribute more.


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This will be put into a pension fund and invested in a mixture of assets from bonds to equities to property, each of which delivers a different level of risk and reward.

If someone still has money in their pension when they pass away, there are a number of options as to what happens next.

If no money has been withdrawn from the pension when the holder dies, then the beneficiaries can usually take it all as a lump sum.

They can either buy an annuity (a fixed income for life) or do a pension drawdown (withdraw flexibly).

Inheritance tax and pension

There are different rules for DB and DC schemes (Image: Getty)

The same options are usually available if the holder of the pension had chosen to take a flexible retirement income by drawing it down gradually before their death.

If, however, they had purchased an annuity, then what beneficiaries are owed depends on the terms of the annuity.

Annuities can be set up on a joint-life basis, which will mean payments don’t stop when one person dies.

Furthermore, if there was a guarantee period inserted into the deal, then payments may continue until that period ends

If this is not the case, then payments will cease.

Harry Byrne

Harry Byrne

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