Using your pension to reduce an Inheritance Tax bill

Using your pension to reduce an Inheritance Tax bill

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Nick Reeves
Published: 14 Jun 2017 Updated: 13 Jun 2022

Traditionally pensions are used to fund your lifestyle in retirement. However, with recent changes to pension death benefits they have also become a popular tool for estate planning. Read on to find out about the rules for passing on a pension and how they could potentially save you Inheritance Tax.

What happens to a pension when you die?

What happens to your pension when you die depends on the type of pension you have. Defined benefit/final salary pensions and annuities won’t usually make any further payments after your death (unless you have protected benefits for a spouse).

Defined contribution pensions such as SIPPs can usually be inherited by your beneficiaries when you die. They can access the money at any age and for any purpose – for example to pay off a mortgage or boost their own retirement savings.

Are pensions taxed on death?

Your beneficiaries may need to pay Income Tax when taking your pension. If you die before age 75 your pension will be passed on tax-free, but if you die after age 75 they will pay Income Tax on the money at their marginal rate.

The rules change in certain situations. Consider speaking to a financial planner to find out more about how your pension may be taxed.

You don’t pay Inheritance Tax on pensions

Your pension won’t be subject to Inheritance Tax as it never becomes part of your estate. This has made pensions a useful estate planning tool. You could potentially save Inheritance Tax by leaving your pension untouched and funding your retirement with other assets that do form part of your estate.

Funding your retirement from other assets

If you have sufficient assets, you could take an income from ISAs, cash savings and other investments. You should consider getting advice from a financial planner if this is something you are interested in. They will be able to forecast your future finances to see if you can afford to leave your pension untouched.

Final salary pensions

Increasing numbers of people are considering transferring out of their defined benefit/final salary pensions to take advantage of this*. These pensions are valuable as they pay a fixed income, but the payments usually stop when you die – so there is nothing left to pass on to the next generation.

If you transfer out of a final salary pension you will receive a cash transfer value. This can then be passed on potentially tax-free – or used to fund your retirement.

Speak to a financial planner

It is worth speaking to a financial planner for advice if you want to know more about passing on a pension. A Tilney financial planner can help you with:

  • How much income you will need to fund your retirement lifestyle
  • Whether you can afford to fund retirement without touching your pension
  • How much your Inheritance Tax bill could be
  • Whether transferring out of a defined benefit pension is in your best interests

Speak to a Tilney financial planner without obligation by booking an initial consultation. We can visit you at your home or local Tilney office, or contact you over the phone.


This article was previously published on Tilney prior to the launch of Evelyn Partners.