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.
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.