Passing on your remaining pension pot can be a good way to help out loved ones in need, but it's important to understand exactly how the system works
Should you be in the fortunate position of having more pension funds than required, you can pass on any remaining pension to your chosen pension beneficiary (those you would like to inherit your pension) when you die.
When opening the pension, you can choose anyone to be your pension beneficiary, it does not need to be a relative, and who this is can be changed at any time. Pensions can be passed onto your beneficiaries without them having to pay inheritance tax on the money they receive. In fact, they should only be required to pay, at most, their own marginal rate of income tax and, in some circumstances, they won't have to pay any tax at all.
Exploring Inheritance Scenarios for Your Pension
Your pension pot is in ‘drawdown’ or is untouched
If you die before the age of 75, you can leave any money held in a personal pension or defined contribution pension run by your employer to your chosen beneficiaries completely free of tax. If you die at the age of 75 or later, the money will be subject to income tax at your beneficiaries’ marginal rate – the highest rate of income tax they pay.
You can nominate anyone, not just relations, to inherit your remaining pension fund as a drawdown account. This lets them draw the money out in lump sums or as income.
It's a good idea to check that your pension scheme will allow this. Some older pension schemes don't offer drawdown, and in these circumstances you might want to take advice about whether having your money in a more modern scheme is worth considering though there will be wider pros and cons of making such a switch.
You belong to a defined benefit or final salary scheme
If you have a defined benefit (DB) or salary-related pension, the pension scheme will generally pay a pension to a surviving widow, widower or partner (but worth checking with the scheme about cohabitees). Pensions are often payable to dependent children too. If you die while working there is often a lump sum payable too.
You have used your pension pot to buy an annuity
Some people use their pension fund to buy something called an annuity, which pays a guaranteed income for as long as you live. In many cases, these will stop paying an income when you die. But if you have a joint life annuity, that will pay an income to your husband, wife or partner (basically, the person you name on the annuity) after you've died. If you have a guaranteed annuity, this will pay out for a set period, typically five or ten years, even if you die within that period. If you've bought one of these three types of annuity, your beneficiary will pay no tax on the pension money they inherit if you die before the age of 75. But if you die aged 75 or older, they'll have to pay income tax at their marginal rate.
You have a State Pension
The rules around whether you can pass on any of your State Pension to your family, and - if so - what part they may be able to inherit are complicated. The government-backed website MoneyHelper has an article that explains how it works.
Remember to consider tax
You can take 25% of your pension fund as tax-free cash once you reach the age of 55, this is due to rise to 57 in April 2028. You may have decided to leave this money untouched in your pension pot, with the idea of leaving it to your children after your death, but if you die on or after your 75th birthday, all of your pension pot – including the 25% that you could have taken as tax-free cash – will be taxed at your beneficiary’s marginal rate of income tax.
Find out more about tax-exempt gifts at MoneyHelper.
Make your wishes known
It's important to make sure you supply your pension providers with details of the people you want to benefit from your pensions. You can't normally do this through your will, as most pensions are not part of your estate which is what your will covers, but you can write an what's called an expression of wishes, or fill in a nomination of beneficiary form (you may be able to do this through your pension provider's app) to inform your pension company about what you'd like to happen with your pensions. You can nominate more than one beneficiary, and decide how much you want each person to receive – but you should be able to alter the details if you change your mind later on.
If you've got any concerns or questions about investing in a pension, it's a good idea to seek help from an independent financial adviser.
More on thinking about retirement
Understanding pension tax relief and annual allowance
Pension tax relief can seem like an alien concept, but it pays to make the most of it.