How to Avoid Inheritance Tax on Pensions

Understanding how to avoid inheritance tax on pensions is crucial for effective estate planning in the UK. While pensions are often considered tax-efficient, they can still be subject to inheritance tax (IHT) under certain circumstances. By taking the right steps now, you can ensure more of your wealth goes to your loved ones rather than to HMRC.

In this article, we’ll explore how pension benefits are treated for inheritance tax purposes, key strategies to reduce exposure, and the importance of professional guidance. For tailored advice, you can book a free consultation with our estate planning experts, or explore our transparent pricing plans.

How Inheritance Tax Applies to Pensions

Inheritance tax is generally charged at 40% on estates exceeding the nil-rate band (£325,000 in most cases). Pensions are not always included in your estate, which makes them an attractive vehicle for passing on wealth. However, not all pensions are exempt.

If you die before age 75 and your pension remains untouched, beneficiaries can usually receive the funds tax-free. After age 75, the funds are taxed as income when drawn by the beneficiary. But in certain cases, such as pension transfers shortly before death, HMRC may treat the pension as part of your estate for IHT purposes.

Common Pension Types and Their IHT Impact

• Defined Contribution Pensions: Often excluded from your estate if not accessed.
• Defined Benefit Pensions: Survivor benefits are typically taxable as income, but may impact IHT depending on scheme structure.
• State Pensions: Cannot be inherited and are not subject to IHT.

How to Avoid Inheritance Tax on Pensions: Key Strategies

1. Leave Your Pension Untouched

One of the simplest ways to avoid inheritance tax on pensions is to leave the pension pot untouched for as long as possible. By drawing from other assets first (such as ISAs or savings), you allow the pension to pass to beneficiaries without forming part of your taxable estate.

2. Nominate Your Beneficiaries

Make sure you’ve completed an “expression of wishes” form with your pension provider. This tells the provider who should receive your pension benefits when you pass away. Without it, the pension might be paid into your estate and become subject to inheritance tax.

To understand how to make this nomination and why it’s vital, this government-backed guide is a great place to start.

3. Avoid Transferring Pension Close to Death

If you transfer pension funds within two years of your death, HMRC might view this as a deliberate move to avoid IHT, especially if you’re in poor health. These transfers can be treated as gifts, potentially attracting inheritance tax.

4. Use Discretionary Schemes Where Possible

Some pension providers offer discretionary schemes, where trustees decide who gets the money. This keeps the funds out of your estate and allows for more flexibility in tax planning.

5. Get Professional Help Early

Speaking to a qualified estate planner ensures your pension nominations are up to date and that you’ve structured your estate efficiently. Read more about our inheritance tax planning services to get started.

What Happens to Your Pension After You Die?

Your pension provider may offer one or more options for how your pension is passed on, such as:

• Lump Sum: Beneficiaries receive the whole pot in one go.
• Drawdown: They receive income over time from the pension fund.
• Annuity: The pension can be used to purchase a guaranteed income for a surviving spouse or dependent.

Remember, if you die before 75, all of the above options are tax-free. After 75, they’re subject to income tax but still avoid IHT in most cases.

Who Inherits Your Pension and What Do They Pay?

Spouse or Civil Partner

If nominated properly, a spouse or civil partner can receive pension funds without inheritance tax. After 75, they’ll pay income tax on withdrawals based on their personal rate.

Children or Other Beneficiaries

Children can inherit pensions, either as a lump sum or through drawdown. Again, tax rules depend on your age at death and the scheme’s rules. Proper nomination ensures tax efficiency.

Is There Inheritance Tax on Pension Withdrawals?

Once funds are withdrawn from your pension, they become part of your estate and could be subject to IHT. This is why many planners advise drawing from pensions later in life while using taxable savings first.

Example Scenario

Suppose you withdraw £100,000 from your pension and leave it in your savings account. If you pass away, this sum is now part of your estate and could be taxed at 40%. If it had stayed in the pension, it could have passed to your children without IHT, depending on the circumstances.

Combining Pensions with Wider Estate Planning

It’s not enough to rely on pension rules alone. To truly avoid inheritance tax on pensions, you need to integrate them into your full estate strategy. This includes:

• Creating a will and lasting powers of attorney
• Using trusts where appropriate
• Making tax-free gifts during your lifetime

Planning early allows you to take advantage of allowances and make well-informed decisions. Book a free consultation to ensure your strategy is aligned with your family’s goals.

FAQs: How to Avoid Inheritance Tax on Pensions

Can pensions be taxed after death?

Yes, but typically only as income if you die after age 75. If not managed correctly, pension funds can also become part of your estate and attract inheritance tax.

What is the two-year rule for pensions?

Transfers made within two years of death can be investigated by HMRC. If the deceased was in ill health, the value might be included in the estate for IHT purposes.

Can I place my pension into a trust?

Some legacy pensions may be written in trust. However, most modern pensions already offer similar protections without needing a trust structure. Check with your provider.

What is a beneficiary drawdown?

This allows your beneficiary to draw from your pension after your death, offering flexibility. It can be tax-free (if you die before 75) or taxed as income (after 75).

Conclusion: Take Action to Protect Your Pension

Learning how to avoid inheritance tax on pensions gives you the power to protect your family’s future. By nominating beneficiaries, avoiding late-life transfers, and integrating pensions into your broader estate plan, you can preserve more of your legacy.

Whether you’re updating your nominations or reviewing your estate plan, our experts can help. Book your free consultation today or view our pricing page to see how we can support you at every step.