Inheriting a Pension Drawdown Fund
When someone who was using pension drawdown dies, the remaining fund does not simply vanish. It can be passed to their nominated beneficiaries, providing a potentially valuable inheritance. However, the rules governing inherited pensions are complex and have changed significantly in recent years, with further major changes coming in April 2027.
Understanding your options as a beneficiary is essential because the decisions you make — particularly around timing and withdrawal method — can have a significant impact on how much tax you pay and how much of the inherited pension you ultimately receive.
Who Can Inherit a Pension?
The deceased member should have completed a nomination of beneficiaries form (sometimes called an expression of wish) with their pension provider. While the pension scheme trustees make the final decision on who receives the benefits, they almost always follow the member's nominated wishes.
Beneficiaries fall into two categories with different options:
Dependants
- Surviving spouse or civil partner
- Children under age 23 (or any age if financially dependent due to disability)
- Anyone financially dependent on the deceased at the time of death
Non-dependant nominees
- Adult children over 23
- Other nominated individuals (e.g., siblings, friends, partners who were not financially dependent)
- Charities and trusts
Options for Beneficiaries
| Option | Dependants | Non-Dependant Nominees | Tax Treatment |
|---|---|---|---|
| Beneficiary drawdown | Yes | Yes (scheme dependent) | Income tax on withdrawals |
| Lump sum | Yes | Yes | Income tax at marginal rate |
| Annuity purchase | Yes | No (usually) | Income tax on payments |
| Combination | Yes | Limited | Varies by method |
Tax on Inherited Pensions: Current Rules (2025/26)
Since April 2024, all inherited pension payments are subject to income tax at the beneficiary's marginal rate, regardless of the age at which the original member died. This was a significant change from the previous rules where inherited pensions were completely tax-free if the member died before age 75.
Tax planning strategies for beneficiaries
- Spread withdrawals over multiple tax years: Taking a large lump sum could push you into a higher tax band. Spreading withdrawals keeps more money in lower bands
- Use beneficiary drawdown: Keep the fund invested and take only what you need each year, managing your tax position carefully
- Time withdrawals with low-income years: If you are between jobs, on maternity leave, or have a gap year, use that time to make withdrawals at a lower tax rate
- Consider pension contributions: If you have earned income, you could withdraw from the inherited pension and make pension contributions to your own pension, getting tax relief
Upcoming Change: Pensions and Inheritance Tax from April 2027
The Autumn Budget 2024 announced a major change: from April 2027, unused pension funds will be brought within the scope of inheritance tax (IHT) for the first time. This is arguably the most significant change to pension death benefits in decades.
What this means in practice
- Unused pension funds will be counted as part of the deceased's estate for IHT purposes
- If the total estate (including the pension) exceeds the IHT nil-rate band (currently £325,000, or up to £500,000 with the residence nil-rate band), 40% IHT may apply to the excess
- The pension will also be subject to income tax when the beneficiary withdraws it
- This creates a potential double taxation scenario where the combined effective tax rate could exceed 60%
Beneficiary Drawdown in Detail
Beneficiary drawdown is often the most tax-efficient option for inherited pensions. The inherited fund is placed into a separate drawdown arrangement in your name, and you can take flexible withdrawals as and when you choose.
Key features
- The fund remains invested and can continue to grow
- You choose when and how much to withdraw
- Withdrawals are taxed as your income at your marginal rate
- There is no tax-free lump sum entitlement on inherited pensions (the 25% tax-free rule does not apply)
- The fund is kept separate from your own pension
- On your death, the remaining fund can potentially be passed to your own nominees (subject to scheme rules and the new IHT rules from 2027)
Practical Steps When You Inherit a Pension
- Contact the pension provider: They will confirm the fund value and your options
- Gather information: Understand the deceased's age at death, the fund value, and whether any tax-free cash has already been taken
- Assess your tax position: Calculate the tax impact of different withdrawal options based on your income
- Consider keeping the fund invested: There is usually no rush to withdraw. Beneficiary drawdown lets you manage the tax impact over time
- Get professional advice: The interaction between income tax, IHT, and pension rules is complex. A qualified adviser can help you make the most tax-efficient decisions
Nominating Your Own Beneficiaries
If you have a pension yourself, this guide highlights the importance of keeping your beneficiary nominations up to date. Key actions to take:
- Complete or update your expression of wish form with each pension provider
- Review nominations after major life events (marriage, divorce, birth of children)
- Consider the tax implications of your nominations in light of the 2027 IHT changes
- Discuss pension death benefit planning with a financial adviser alongside your wider estate plan
Next Steps
If you have inherited a pension, take time to understand your options before making any decisions. The tax landscape for inherited pensions is changing rapidly, and decisions made now can have significant financial consequences. Speak to a pension specialist who can model the tax impact of different scenarios and help you develop a withdrawal strategy that minimises your overall tax liability.