Since pension freedoms were introduced, it has been possible to pass on a personal pension (defined contribution, including a SIPP) to whomever we wish. This has distinct advantages for inheritance tax (IHT) planning as pensions fall outside of the estate for IHT liability.  

So, now we know that pensions can be passed on to one or more beneficiaries, but what happens when you inherit a pension? And what do you need to consider when you receive their inherited funds?

The death benefits rules offer various advantages but can also be complex, and if benefactors don’t plan carefully, they can find themselves with issues to deal with. The main consideration if you are a benefactor is the rules of whether beneficiaries’ drawdown is permitted (i.e., whether an individual is entitled to draw income from the pension). It is important that the benefactor makes clear who they want to benefit from their pension in their expression of wish form. Dependants as per HMRC’s definition should be eligible for beneficiaries’ drawdown, as should beneficiaries named in the expression of wish.

Another sticking point can be the pension providers. They all have their own rules and conditions, which may not offer beneficiaries’ drawdown. Working on the basis that the pension moves into the beneficiary’s control, what are your options, firstly if you’re still working and second if you’re already in retirement?

If you’re still working, you could leave the money in the pension to grow over time, maybe to supplement your own pension savings. Dependent on your circumstances, it may be more tax efficient to use withdrawals from the pension as income, and to increase your contributions into your own pension from your earnings, as you would receive more tax relief this way.

Also, if you are in a workplace scheme where the employer matches your contribution this could further boost your pension. If the workplace pension is taken pre-tax, you could also save on Income Tax and National Insurance contributions. The downside to this is that you would be using up accessible cash while paying into a pension that cannot be accessed until retirement age (55 or over).

For beneficiaries who are already in retirement, your decisions may be harder, and very much dependent on your circumstances. You could for example, use the tax-free lump sum for income to boost your spending power in early pension years and reduce the amount taken from your own pension.

Other considerations you will have to take into account include issues around tax, such as whether the inherited pension money will be taxable or tax free (this will be determined by whether the benefactor was under or over age 75 on death), as well as how to make the best use of your income tax allowance and tax bands.

There is also the option to keep the pension and pass this on to future generations, but this isn’t possible for all types of pensions. Pension freedoms were introduced just seven years ago, and the death benefits only apply to personal pensions, not final salary pensions, which have their own rules.

But, as you can be seen, this is not a simple area, and it is easy to be caught out if you make the wrong decision.

If you are the beneficiary of a personal pension and require help in making the right decision, please call 0191 281 8811 and we will arrange a free, no-obligation consultation with one of our experienced Advisers.

The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.