Can I pass on my pension when I die?

Will my pension  die when I do? It’s a stark question, but one with a positive answer. Most pensions can still be passed on – with one caveat. In her 2024 Autumn Budget, the chancellor announced that pensions would no longer sit outside an estate. Effectively this means pension funds are no longer exempt from inheritance tax (IHT). From the beginning of the 2027 tax year, leaving someone an unspent pension could land them with an IHT bill of 40%.  

This change sent a minor shockwave through many middle and high income households who had already planned to pass some or all of their pension on when they die. For many people, pensions have often been the last asset to be touched when drawing income in retirement, precisely because of their IHT-free status. Putting money into pensions meant reducing the size – and IHT liability – of an estate, plus being able to pass on significant sums of money, all in one fell stroke.

However, now the dust has settled, clear, tax-efficient estate planning alternatives are emerging. In this article, we’ll look at your options for gifting or donating some of those pension savings tax free, during your lifetime. 

What happens to my pension when I die?

What happens to your pension when you die depends on the type of pension you hold, and your age at the time of your death.  If you have a Defined Benefit (DB) pension, sometimes referred to as a final salary pension, it guarantees you a fixed income in retirement based on your salary and length of service, primarily funded by your employer. 

Unlike a Defined Contribution (DC) pension, where both you and your employer contribute and which can be passed on more freely, the transfer of a DB pension to beneficiaries works differently. While you generally can’t pass on the full value of a DB pension, these plans often provide certain benefits upon your death. These may include a surviving spouse’s or civil partner’s pension, a lump sum payment, or a percentage of the pension income to a spouse, civil partner, or nominated beneficiary.

On the other hand, your state pension can’t be passed on to anyone.

When it comes toa DC pension, the way benefits are passed on to a beneficiary may depend on the type of scheme, the circumstance of your death, and the age at which you die. This distinction is important, as whether you die before or after the age of 75 will affect what your beneficiary can expect to receive.

What is the ‘rule of 75’?

With DC pensions, if you die before the age of 75 then in most cases, your named beneficiary won’t pay income tax on withdrawals from the pension. However, if you die after the age of 75, they will pay income tax on any withdrawals or when they cash in. The income tax rate will vary depending on whether they are a basic rate, higher rate or additional rate taxpayer.

The rule of 75 can seem quirky and unnecessarily complex. As with all aspects of pension planning, it’s best to discuss with your financial adviser if you’re unsure about what it could mean for your estate. This is especially valuable if you have several pensions or hold a mix of DB and DC plans.

Even with a possible IHT liability, your pension savings can still do great things  after you’ve gone. But that money could start to do even more, even sooner, if you begin to pass it on during your lifetime.

Gifting and donating – how to pass money on tax-free

Each tax year, you can gift up to £3,000 tax free. Using that full annual gifting exemption (£6,000 for a couple) to give money to loved ones during your lifetime steadily reduces the size of your estate, and lowers your eventual IHT bill. And, if you didn’t gift in the previous tax year, you can carry forward that allowance. This means that a couple could potentially gift as much as £12,000 in a single year.

Although the gifting allowance is set at £3,000 per year, there’s no limit on the size or value of the gift itself. You can make a gift  of any size, but if you die within seven years of the gift, the money may still count as part of your estate. The good news is that this tax liability does start to ‘taper off’ after three years on any amount over the IHT threshold of £325,000 – so the longer you live (or the sooner you make substantial gifts) the better chance your gift has of passing in its entirety.  

According to HMRC a gift can be ‘anything you give away’.  This includes money, property or land, stocks and shares listed on the London Stock Exchange, even jewellery or antiques. It also covers unlisted shares if you held them for less than two years before your death.

These larger gifts are, in tax-jargon, sometimes referred to as PETs or Potentially Exempt Transfers; meaning that they are potentially tax-exempt, so long as you live for the full seven years.

You can also make gifts of up to £5,000 to a child getting married, or £2,500 to a grandchild or even great-grandchild. That’s a lovely honeymoon – tax free. You can also make any number of smaller gifts of up to £250 in a tax year, so long as it doesn’t tip you over your tax allowance limit.

Donating to charity can help your IHT bill

If there is a charity or organisation that is particularly close to your heart, you could benefit them while making a significant difference to your IHT bill too. Gifting more then 10% of your estate not only reduces the size of your IHT liability, it can also cut your IHT rate from 40% to 36%. That's a generous gift to leave both your favourite charity, and your family

Spend your pension – but not on yourself  

The other option is to draw on the pension and spend – but not necessarily on yourself. Choosing to help cover nursery or school fees, helping to pay part of a mortgage or opening a Junior ISA or even a Child Pension are ways to cascade money through the family during your lifetime, rather than after*. Making regular payments to other family members from disposable income remains a tax-free option – with the caveat that any payments you make regularly will be treated as tax-free gifts so long as they genuinely are from surplus income you don’t need to live on.

It can be very satisfying to see your money being put to good use while you’re still around to see it.

Who can I pass my pension onto?

A pension doesn’t have to be earmarked for children or even relatives; you can leave it to anyone.  However, you can – and should - nominate the beneficiary you want to receive the pension or a proportion of it, when you die.

Under the proposed change to the IHT rules, you can still pass on both a DB or DC pension to your spouse or civil partner without paying IHT, but when they die, it stops there. For DC pensions, any money remaining in the pension (if it’s passed down the family again) will be counted as part of the estate and become taxable. Not only that, but your beneficiary needs to be aware that, in addition to a possible IHT bill, they may also find themselves paying income tax when they start to withdraw the pension money.

Passing money on sooner rather than later can be a powerfully positive step towards achieving financial wellbeing earlier in life. A ‘living legacy gift’ can enable other family members to start businesses, pay off mortgages or send grandchildren on an unforgettable gap year without waiting to inherit a lump sum. With many of us living longer, you might be in your sixties and financially stable before you receive an inheritance.

The value of financial advice for your legacy planning

According to recent research by SJP, two thirds (68%) of UK adults believe it’s important they leave an inheritance, and over half (55%) of future retirees expect to provide financial support from savings or disposable income to their family.¹

As we have seen, tax regulations can change overnight. Clear financial advice from a qualified financial adviser can help you see the bigger picture, and adapt your estate planning to match. You may have more options and opportunities to pass a pension on than you imagine.

You don’t need to change your goals; just the route you take to get there.

Want to talk about your legacy planning? Do get in touch with us now.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

*Please note that a Junior ISA or Child's Pension can only be set up by a parent or legal guardian. After that, anyone can contribute.

Source
¹Research conducted for St. James’s Place by Opinium, among 4,000 UK adults between 27th February – 8th March 2024. All results are weighted to nationally representative criteria.