How your pension can save you inheritance tax

Rachael Oku

by , VP Brand and Communications

at PensionBee

26 Jan 2024 /  

How your pension can save you inheritance tax

Regularly saving money into your pension has lots of well known benefits like compulsory contributions from your employer and tax relief from the government. It’ll provide you with a retirement income in old age and you can take up to 25% tax-free from age 55.

Pensions can even help you take care of your family once you’re gone, safeguarding your savings and reducing the amount of inheritance tax they’ll pay.

What is inheritance tax?

When you die, your beneficiaries will be charged inheritance tax on the items in your estate such as property, money and belongings. The amount of inheritance tax collected by the government will vary depending on the total value of your estate and who your beneficiaries are.

How does inheritance tax work?

The standard threshold for inheritance tax is £325,000 so if your assets aren’t worth more than this inheritance tax won’t be charged. If your estate is worth more but you leave everything to your spouse, civil partner or a charity, inheritance tax won’t apply.

However, if you have a large estate and decide not to leave it to a spouse, civil partner or a charity, inheritance tax of 40% will be charged on anything above a value of £325,000.

  • Example 1

If your estate is worth £250,000 no inheritance tax will be charged as it’s £75,000 below the threshold.

  • Example 2

If your estate is worth £500,000 and you leave it to your spouse, it will be free from inheritance tax.

  • Example 3

If your estate is worth £500,000 and you leave it to your best friend, inheritance tax charges will apply. The estate value is £175,000 over the threshold and at a rate of 40% the inheritance tax due will total £70,000.

Several reliefs and exemptions also apply on things like gifts, business shares or assets and agricultural land so if you’re unsure about the inheritance tax rates it’s worth checking the website for guidance.

If you leave 10% or more of your estate to charity, a reduced rate of 36% inheritance tax will be applied to estates valued over £325,000 and if you decide to leave your home to your children or grandchildren your inheritance tax threshold will rise to £450,000.

Pensions and inheritance tax

Unlike cash savings, pensions sit outside your estate and will not count towards your inheritance tax threshold when you die. For this reason pensions are a great way of leaving money to your loved ones while ensuring they can keep as much of your money as possible.

Some conditions will apply depending on how old you are when you die and the type of pension you have in place.

Inheritance tax on defined contribution pensions

If you have a defined contribution pension like those offered by PensionBee, it’s relatively straightforward to pass your savings to your beneficiaries. If you die before age 75 and haven’t touched your pension, your beneficiaries have two years to claim your entire pot tax free.

If you’re older than 75 when you die, your defined contribution pension won’t be subject to inheritance tax, however your beneficiaries will have to pay income tax at their usual rate. As a PensionBee customer you can easily set your benificiaries by heading to the account section of your BeeHive.

Inheritance tax on drawdown pensions

If you die before 75 but have already started accessing your pension via drawdown it’s possible for your beneficiaries to access your pot as a tax-free lump sum or opt to receive drawdown payments tax-free. In this instance beneficiaries can also choose to use the money to buy an annuity and won’t have to pay tax on any of the payments they receive.

Inheritance tax on defined benefit pensions and annuities

If you have a defined benefit pension (also known as a final salary pension) or an annuity, you may find it more difficult to pass this on to your beneficiaires. If you haven’t retired and die before you reach 75 years of age your beneficiary will usually receive a tax-free lump sum.

If you’re older than 75 when you die it’s likely that your spouse, civil partner or dependant will receive a portion of your pension, however this may be subject to tax charges.

Passing on your pension

To ensure your pension goes to your loved ones hassle-free when you die, you’ll need to complete a few steps:

  • Consider setting up a defined contribution pension if you haven’t already, as this will give your beneficiaries the most flexibility
  • Locate your old workplace pensions and weigh up the pros and cons of transferring them into one scheme. This can make things a lot easier for your beneficiary to manage and will ensure they have access to all of your pension savings
  • Notify your pension provider of who your beneficiaries are and keep this information up to date
  • While it’s not essential in order to pass along your pension, writing a will can help remove any doubt when it comes to dividing your estate and respecting your wishes when you die

All of PensionBee’s pensions are defined contribution pension plans which have a value based on the amount you pay in and the performance of your investments. When you join PensionBee we’ll help you track down your old pensions and transfer them into one manageable pot. You’ll be able to keep track of your contributions in your online dashboard and can also update your beneficiary details in just a few clicks.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

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