Most people think of pensions as savings that will help pay for their retirement. But - because we don’t know when we’re going to pop our clogs - there’s a good chance there will be some money left in your pension pot after you die. Maybe a lot.
If you're a couple lucky enough to have more than £1m in your estate, your loved ones are going to be subject to 40% inheritance tax on anything above this amount (if you’re single, the threshold is £500k).
However, if you pass on a higher proportion of your savings from your pension pot instead, you could reduce, or in some cases, eliminate their inheritance tax bill.
This is a flat 40% tax on the portion of your estate that is valued above the inheritance tax threshold.
If you’re wondering what your ‘estate’ is, it’s the net worth of an individual or couple, which includes their property (or properties), possessions of value and money in the bank, minus any debts they might have.
Somewhat confusingly, the threshold for paying inheritance tax is made up of two parts and largely depends if you are leaving a property behind. These are the amounts you can leave to your loved ones without getting taxed.
*For the 2023-2024 tax year.
Remember: inheritance tax is paid on the portion of your estate that exceeds these thresholds. So, for example, if a couple passes on £1.2 million (including a property), £200k of that inheritance is taxable, so the total inheritance tax is £80k.
The executor of the will. This is the person who manages the estate and they are responsible for paying any inheritance tax due, though not with their own money.
Ideally, the executor should be a close relative or friend who you would trust with your life (no pun intended). They should have a good understanding of your will and make sure the right amounts go to the right people (based on your wishes).
Any money you pass on from your pension won’t be subject to inheritance tax following a huge change to pensions law this year. The chancellor, Jeremy Hunt, announced that the Government would abolish the pension lifetime allowance charge in the 2023-2024 tax year. This means there is no longer a limit to the amount you can save in your pension.
Under the previous rules, any pension valued above the lifetime allowance of £1,073,100 was subject to a jaw-dropping 55% tax if your beneficiaries received it as an excess lump sum (there’s more on this below).
This makes it a solid option as a way to avoid inheritance tax. It means you could, theoretically, pass on millions of pounds in unused pension money to your loved ones without having to worry about HMRC taking a big chunk of it. There are, however, a few catches.
If you haven’t given your pension provider any named beneficiaries – typically your children, grandchildren and other people you’ve mentioned in your will – to inherit your unused pension funds, it will be up to the trustee (the pension provider) to determine who should be paid what.
Usually they’ll choose your closest family members. But to avoid any delays or family disputes, it’s better to have everything in writing. If you’re a Penfold pension holder, you can add beneficiaries just by heading to the ‘Profile’ section of our app or account online.
If you feel you need help, a qualified financial adviser can help you nominate pension shares to your beneficiaries. This is called creating an ‘expression of wishes’ to make clear who should receive your remaining pension funds after you die. They can also advise you on the most tax-efficient way to pass on your inheritance and remaining pension savings to your loved ones.
Keep your pension records safe and accessible and tell your beneficiaries where to find them. After you die, your beneficiaries will need to contact the provider in order to access the remaining funds. The type of pension you have makes a difference to what your beneficiaries will inherit.
This depends on whether you have a defined benefit or a defined contribution pension.
A defined benefit pension is also sometimes called a final salary scheme. This is a fixed sum that you receive from your former employer. It is a guaranteed income for your retirement, however long you live.
After you die, your defined benefit pension income will go to a dependant, such as your spouse, civil partner or child under 23. If your pension scheme allows it, it can sometimes be paid to other people, although this will count as an unauthorised payment which will be taxed up to 55%.
If you die before retirement, most schemes will pay out (to a dependant) a lump sum equivalent to two to four times the deceased person's salary, which is tax-free if you die before the age of 75.
Most workplace and private pensions are defined contribution schemes. In a workplace pension, an employer and employee contribute a fixed amount each month. In a private pension, the individual contributes whatever they like into a Self-Invested Personal Pension (SIPP).
If you pass on a defined contribution pension, this will be paid to anyone who is named as a beneficiary of the pension, although they may need to pay income tax on what they take out.
If the person died after their 75th birthday:
If the person died before their 75th birthday:
Remember: there is no inheritance tax to pay on inherited pensions. If you have inherited pensions, consider consolidating them to build your pension pot.
You can do this by transferring them to a SIPP (Self-Invested Personal Pension) or a private pension account in which you can invest up to £60k each tax year (your annual allowance). This also means you can:
It’s much easier to manage your pension when there’s only one password to remember! However, there are some things you should consider before combining your pensions – read them here.
The bonus is you’ll get contributions into a pension pot topped up by between 20% and 45% tax relief. You can exceed the £60k annual allowance if you didn't reach it in the last three tax years, which means you could contribute up to £180k in one year (this is called ‘carry forward’).
Keeping more of your savings in your pension instead of your estate can be an effective way to avoid or reduce an inheritance tax bill. Thanks to the abolition of the Lifetime Allowance Charge, it’s now easier to pass on more of your savings to your loved ones.
At Penfold, you can combine all your pensions in five minutes, then top-up, adjust, or pause your contributions at any time.
With investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice and past performance is not a reliable indicator of future performance.