Do Pensions Form Part of an Estate in the UK? Inheritance Rules Explained

Wondering if pensions form part of an estate in the UK? Learn whether pensions are subject to inheritance tax, how they are passed on and how to manage pension inheritance.

When someone passes away, their assets, such as property, savings and investments usually form part of their estate for inheritance purposes. But what about pensions?

The good news is that most pensions do not form part of an estate, meaning they are not subject to inheritance tax (IHT). However, there are exceptions, and whether a pension is included in an estate depends on:

  • The type of pension (Defined Contribution, Defined Benefit, or State Pension).

  • Whether the pension holder nominated a beneficiary.

  • If the pension was already withdrawn before death.

This guide explains when pensions are and aren’t included in an estate, how they are inherited, and how to ensure your pension passes on tax-efficiently.

When Do Pensions Form Part of an Estate?

Most pensions do not form part of an estate because they are held in trust by the pension provider. However, there are situations where a pension might be included in an estate, such as:

  1. If a Lump Sum Payment Is Paid to the Estate

    • If a pension holder did not nominate a beneficiary, some pension providers may pay the pension into the estate instead.

    • Once the money is in the estate, it could be subject to inheritance tax if the estate exceeds the £325,000 threshold.

  2. If the Pension Has Already Been Withdrawn

    • If the pension holder took a lump sum or regular withdrawals before death, any remaining funds in their bank account or investments become part of the estate.

    • This means the withdrawn pension could be taxed at 40% if the estate is over £325,000.

  3. If It’s a State Pension

    • The State Pension stops upon death and is not passed on, except for limited cases where a spouse may inherit extra payments.

    • Any unpaid State Pension due before death becomes part of the estate.

  4. Certain Older Workplace Pensions

    • Some older workplace pensions (before pension freedoms in 2015) may have different rules and could be included in the estate.

When Do Pensions NOT Form Part of an Estate?

The majority of workplace and private pensions do not form part of an estate because they are typically held in trust by the pension provider. This means:

  • They pass directly to nominated beneficiaries and do not go through probate.

  • They are not subject to inheritance tax (unless paid into the estate).

  • Beneficiaries can receive the pension tax-free (if the deceased was under 75) or pay income tax (if over 75).

Defined Contribution Pensions (Workplace & Private Pensions)

  • These pensions are not usually included in the estate because they are held in trust.

  • If a beneficiary was nominated, the pension provider pays the benefits directly to them.

  • If no beneficiary was nominated, the provider may pay the lump sum into the estate, which could be subject to IHT.

Defined Benefit Pensions (Final Salary Pensions)

  • These pensions do not form part of an estate and usually provide a reduced survivor’s pension to a spouse or dependent.

  • A lump sum may be paid if the pension holder dies within a set period after retirement, and in some cases, this could be included in the estate.

Annuities

  • Single-life annuities – Stop when the pension holder dies and do not form part of the estate.

  • Joint-life annuities – Continue paying a reduced income to a spouse or dependent but do not form part of the estate.

  • Guaranteed period annuities – If the annuity was set up with a guaranteed payment period, the remaining payments may be included in the estate if no beneficiary is named.

Are Pensions Subject to Inheritance Tax?

Most pensions are not subject to inheritance tax because they are held in trust and paid directly to beneficiaries. However, if a pension is paid into the estate, it may be subject to 40% inheritance tax if the estate is worth over £325,000.

Tax Rules for Inherited Pensions

  • If the pension holder dies before age 75

    • The pension can be passed on tax-free to a nominated beneficiary.

    • This applies whether the beneficiary takes the money as a lump sum or regular drawdown payments.

  • If the pension holder dies after age 75

    • The pension is not subject to inheritance tax but is taxed as income when withdrawn by the beneficiary.

    • If the beneficiary is a basic-rate taxpayer (20%), they pay 20% tax on withdrawals.

    • If the beneficiary is a higher-rate taxpayer (40%), they pay 40% tax on withdrawals.

How to Keep Your Pension Outside of Your Estate

To ensure your pension does not form part of your estate, follow these steps:

1. Nominate a Beneficiary with Your Pension Provider

  • Complete a nomination of beneficiaries form with your pension provider.

  • You can name spouses, children, partners, or even a trust.

  • If no beneficiary is named, the pension provider may pay the lump sum into the estate, potentially triggering inheritance tax.

2. Avoid Large Pension Withdrawals

  • If you withdraw your pension and keep it in a bank account, it becomes part of your estate and could be taxed at 40%.

  • Leaving funds inside the pension keeps them outside of inheritance tax calculations.

3. Use Pension Drawdown Instead of Lump Sums

  • If a beneficiary takes the inherited pension as a lump sum, they may face high income tax charges.

  • Instead, they can use drawdown, taking small amounts to spread the tax liability over multiple years.

4. Consider a Spousal Bypass Trust

  • If you are concerned about tax, you can set up a spousal bypass trust, which allows pension funds to be held outside of your estate while providing financial security to loved ones.

  • Trusts are complex, so getting financial advice is recommended.

Final Thoughts: Do Pensions Form Part of an Estate?

  • Most pensions do not form part of an estate because they are held in trust.

  • State Pensions stop upon death, but some payments may be inherited by a spouse.

  • Defined Contribution pensions pass directly to beneficiaries and are usually inheritance tax-free.

  • If a pension is withdrawn and held in cash, it becomes part of the estate and could be taxed at 40% if the estate exceeds £325,000.

  • To ensure pensions pass on tax-efficiently, nominate beneficiaries and avoid withdrawing large sums unnecessarily.

If you’re unsure about your pension’s inheritance rules, check with your pension provider or seek advice from a financial planner to ensure your pension is passed on in the most tax-efficient way.

For more information, visit GOV.UK – Pension and Inheritance Tax.