Why Pensions Are a Powerful Inheritance Tool
Pensions have become one of the most tax-efficient ways to pass wealth to your children in the UK. Since the pension freedoms introduced in April 2015, defined contribution (DC) pensions can be inherited by anyone you nominate, with potentially no tax to pay at all. This has transformed pensions from purely retirement income vehicles into powerful estate planning tools.
The key advantages of passing your pension to your children rather than other assets include:
- Tax-free inheritance if you die before 75 — your children pay zero tax on inherited DC pension funds
- Currently outside your estate for IHT — pensions are not counted in your estate (until April 2027)
- Flexible withdrawal options — children can take lump sums or keep the pension invested in drawdown
- No age restrictions — adult children can inherit regardless of their age or financial dependency
Many financial planners now recommend spending other assets first in retirement and preserving your pension as long as possible, specifically because of these inheritance advantages. However, this strategy needs careful review in light of the upcoming April 2027 changes.
The Age 75 Rule: Tax-Free vs Taxable
The single most important factor determining how much tax your children will pay on an inherited pension is your age when you die. This is commonly known as the age 75 rule.
| Your Age at Death | Tax on Lump Sum to Children | Tax on Drawdown Income to Children |
|---|---|---|
| Under 75 | Tax-free (within the lump sum and death benefit allowance of £1,073,100) | Tax-free |
| 75 or over | Taxed at child's marginal income tax rate (20%, 40%, or 45%) | Taxed at child's marginal income tax rate |
Death Before 75: Completely Tax-Free
If you die before your 75th birthday, your DC pension can be passed to your children with no income tax to pay. They can choose to take it as a tax-free lump sum, or they can transfer it into beneficiary drawdown and take tax-free income for the rest of their lives. The only limit is the lump sum and death benefit allowance (LSDBA) of £1,073,100 for tax-free lump sum payments.
Death at 75 or Over: Income Tax Applies
If you die at 75 or older, your children will pay income tax at their marginal rate on any withdrawals from the inherited pension. However, there is still a significant advantage: the pension itself passes to them without any inheritance tax (under current rules), and they control when and how much they withdraw. A child who is a basic-rate taxpayer would pay only 20% tax on withdrawals, compared to the 40% IHT that might apply to other inherited assets above the nil-rate band.
How to Set Up Your Pension for Your Children
To ensure your pension reaches your children when you die, you must take these steps:
- Complete an expression of wish form with every pension provider you have. Name your children as beneficiaries and specify the percentage each should receive
- Choose the right pension structure — DC pensions offer the most flexibility for passing to children. If you hold a DB pension, consider whether a transfer to DC might be appropriate (but only with professional advice)
- Keep your pension invested — if your goal is to pass your pension on, consider spending other assets first in retirement and leaving your pension pot untouched or in drawdown
- Review your nominations regularly — update your forms after any major life event such as the birth of a grandchild, a child's marriage, or a change in your circumstances
- Tell your children about your pensions — they need to know which providers to contact when you die
DC Pensions vs DB Pensions: What Your Children Can Inherit
The type of pension you hold significantly affects what your children can receive.
| Feature | DC Pension | DB Pension |
|---|---|---|
| Adult children can inherit | Yes — any age, any amount | Dependant's pension for under 18/23 only |
| Tax-free if death before 75 | Yes | Lump sum only; dependant's pension always taxed |
| Beneficiary drawdown available | Yes | No |
| Lump sum option | Yes — entire fund | Death-in-service benefit only |
| Nomination flexibility | Any person or charity | Restricted to dependants |
If you have a DB pension and want to maximise what your adult children inherit, you may want to explore whether transferring to a DC pension is appropriate. However, this involves giving up a guaranteed income for life, so it should only be done with regulated financial advice. See our guide on whether it is worth transferring a final salary pension.
The April 2027 IHT Changes: What Parents Need to Know
From April 2027, the government plans to bring unused pension funds within the scope of inheritance tax. This is the biggest change to pension inheritance rules since the 2015 pension freedoms, and it will significantly affect the strategy of using pensions as inheritance vehicles.
Under the proposed rules:
- Your pension fund at death will be added to your estate for IHT calculation purposes
- If your total estate (including pension) exceeds £325,000 (or £500,000 with the residence nil-rate band), IHT at 40% could apply to the excess
- There is a risk of double taxation where both IHT and income tax apply to the same pension funds if you die at 75 or over
- The spousal exemption means pensions left to a surviving spouse or civil partner will remain IHT-free
This change does not eliminate the value of passing pensions to children, but it does reduce the tax advantage. The strategy of preserving your pension and spending other assets first may no longer be as effective. Read our detailed guides on pensions and IHT from April 2027 and pension inheritance tax changes 2027.
Strategies to Maximise What Your Children Inherit
Even with the 2027 changes, there are steps you can take to maximise the pension wealth your children receive:
- Spend other assets first — draw income from ISAs, savings, and other investments before touching your pension, as pensions still offer better tax treatment on death than most alternatives
- Consider the order of death benefits — leaving your pension to your spouse first (IHT-free under spousal exemption) and then to children on the second death can be more efficient
- Use beneficiary drawdown — encourage your children to take income gradually from beneficiary drawdown rather than a lump sum, to manage their income tax liability
- Make lifetime gifts — consider gifting other assets during your lifetime (using the £3,000 annual exemption and potentially exempt transfers) to reduce your estate below the IHT threshold
- Review your overall estate plan — ensure your pension nominations, will, and IHT planning work together coherently
What Your Children Need to Know
When you die, your children will need to contact your pension provider to claim the death benefits. They should know:
- The name of every pension provider you have
- Your pension reference numbers or policy numbers
- That they need to make a claim — pension death benefits are not paid automatically
- That they have options (lump sum, drawdown, annuity) and should consider the tax implications before choosing
- That if you die before 75, they should claim within two years to ensure the lump sum is tax-free
Next Steps
Review your pension arrangements and ensure your beneficiary nominations are up to date. Consider speaking to an FCA-regulated adviser about how the April 2027 IHT changes affect your specific situation, particularly if you have significant pension savings. Get matched with an adviser for personalised guidance.