When someone dies, their pension will be dealt with in accordance with the rules of their pension provider. We look at some of the most common scenarios.
After years of contributions, pension pots can contain substantial funds and those who have made the savings will want to be sure they are passed on to their loved ones after death where possible.
The first £325,000 of someone’s estate is exempt from Inheritance Tax (IHT). An individual is entitled to take a lump sum from their pension on retirement of 25 percent of the amount saved, free of income tax.
If any of this sum remains in their bank account at the time of death, it will become part of the estate for IHT purposes. It is therefore possible that the lump sum could push the value of an estate over the IHT threshold.
Spending the money or gifting it to beneficiaries may avoid IHT, but if valuable assets are bought, they will still form part of the estate. Any cash gifts made within the seven years prior to death will also count towards the value of the estate for IHT purposes.
Pension pot funds
The pension itself is normally held in trust and as such wouldn’t usually be counted when calculating IHT.
Depending on the pension provisions, it is often possible to leave funds to a beneficiary on death.
Examples include where a joint annuity has been purchased and payments will continue to the other party, usually a spouse or civil partner, or a guaranteed period annuity where payments may continue for a set number of years.
Alternatively, a beneficiary may be left the remaining pension in lump sum form. It would normally pass directly from the pension trustees to the named individual, without ever forming part of the estate, and so IHT would not be payable on the amount transferred.
Pension trustees have a duty to consider the needs of any dependents of the deceased, such as minor or disabled children or a partner, and have discretionary power to give funds to support those who need it.
It is possible that if the trustees could not reach a decision on the distribution of the funds, they could pay the money to the estate, in which case it would be assessed for IHT purposes.
To fully understand what will happen to your pension funds in the future, you should speak to your provider and see what rules are in place and what options are available for passing funds on to your chosen beneficiaries.