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What happens to our pensions on death?

Tax | Inheritance Tax Helpful? 7

Asked by Rekrap, submitted 25 May 2014.

Open Quote My wife and I are both 67 years old and pay into pension schemes - wife Stakeholder and me a SIPP - at our maximum contribution of £2,880 per annum (to qualify for tax relief with no earnings).

I understand that on our demise these funds fall outside Inheritance tax and can be paid directly to our beneficiaries? The intention is that before age 75 these funds be put into income drawdown. Presume that at this stage the funds revert and would then form part of our estates for IHT purposes?
End Quote

Answered by Justin on 02 June 2014

The treatment of pensions on death depends on both your age and whether they have been ‘crystallised’, that is tax-free cash taken and drawdown entered into (even if you have not withdrawn any income).
If you have yet to crystallise a pension and die before age 75 then the pension fund can either pass as a tax-free lump sum (outside of your estate) to a dependent or be used to provide them with a taxable income, either via drawdown or by buying an annuity.
Dependents are defined as a spouse, common law partner, child under 23 or where you can prove financial dependency (for example, a child above 23 who suffers from a disability).

If you die aged 75 or over with an uncrystallised pension, or have already crystallised a pension (i.e. in drawdown), then the pension fund can still pass as a lump sum to a dependent on death but will suffer a 55% tax charge. Alternatively it can be used to provide a taxable income for a dependent as per above.

Inheritance tax will not be an issue in any of these scenarios since pension funds do not form part of an individual’s estate (the technical reason being the monies are effectively held in a trust, hence do not personally belong to you).

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

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