What Happens to Your Pension When You Die?
For many people, a pension is one of the most significant assets they will build in their lifetime. Yet what happens to it on death — who receives it, how, and what tax applies — is often misunderstood. With important changes ahead, now is a good time to review the current rules and what will change from April 2027.
The Current Position: Income Tax and the Age 75 Threshold
Under current rules, the income tax treatment of pension death benefits mainly depends on whether the pension holder dies before or after age 75.
If death occurs before age 75, beneficiaries can usually receive the pension funds free of income tax, either as a lump sum or through drawdown, provided the scheme is notified and the funds are designated within two years.
If death occurs at age 75 or older, beneficiaries can still receive the funds, but withdrawals are taxed at their own marginal income tax rate, which may be 40% or more for higher earners.
The Two-Year Rule
If death occurs before age 75, the pension scheme must be notified and the funds paid out or moved into drawdown within two years of the scheme becoming aware of the death.
If this deadline is missed, the income tax exemption is lost and the funds are taxed at the recipient’s marginal rate, so prompt notification is essential.
David Lea, Partner & Head of Private Client, Berry & Lamberts Solicitors
Defined Contribution Versus Defined Benefit Schemes
The tax-free treatment above mainly applies to defined contribution pensions, where the pot is built from contributions and investment growth.
Defined benefit schemes work differently: dependant’s pensions are generally taxable regardless of the member’s age at death, and death in service benefits have separate rules.
The Lump Sum and Death Benefit Allowance
Tax-free lump sums paid to beneficiaries are capped by the deceased’s available Lump Sum and Death Benefit Allowance (LSDBA), currently £1,073,100. Any excess is taxed at the recipient’s marginal rate, mainly affecting larger pension pots.
During lifetime, a tax-free cash lump sum of up to 25% of the pension pot may also be available, capped at £268,275 under the Lump Sum Allowance (LSA).
The Importance of Nomination Forms
Pension death benefits usually fall outside a will and are paid at the trustees’ discretion, taking account of any expression of wishes or nomination form.
Nomination forms should be kept up to date, especially after major life events such as marriage, divorce or children, to avoid delays or unintended outcomes.
A Significant Change: Inheritance Tax from April 2027
From 6 April 2027, most unused pension funds and pension death benefits will fall within the scope of inheritance tax (IHT), following a change announced in the Autumn Budget 2024.
Currently, pension funds held at death are generally excluded from the estate for IHT purposes. From April 2027, unused pension pots will be counted with other assets when assessing whether IHT is due.
The government estimates this will bring around 10,500 more estates into IHT and increase the IHT payable by about 38,500 estates each year.
Key points include:
- The spousal and civil partner exemption remains, as do gifts to registered charities.
- Personal representatives, rather than pension providers, will report and pay any IHT due on pension assets.
- Where death occurs after age 75, pension assets could face both IHT and income tax when beneficiaries draw funds down.
What This Means in Practice
The April 2027 changes mark a major shift in estate planning. For those with sizeable pension pots and other assets, estates that previously fell outside IHT may now become taxable.
Now is a good time to review wills, lasting powers of attorney and wider estate planning arrangements, alongside financial advice on pension drawdown and beneficiary nominations.
Although the changes take effect from April 2027, decisions made now about contributions, drawdown and nominations may affect the eventual IHT position.
If you would like to review your estate planning or understand how these changes may affect you and your family, please get in touch with a member of our Private Client Team. We would be happy to talk through your options and explain how we can help.