TL;DR
- Currently, DC pension pots pass outside the estate and are not subject to inheritance tax on the member death.
- From 6 April 2027, unused DC pension funds will be included in the IHT estate under the Autumn 2024 Budget.
- DC pensions passed to a spouse or civil partner remain tax-free regardless of the IHT change.
- Death before 75: pension funds can be passed to any beneficiary free of income tax.
- Death after 75: beneficiaries pay income tax on withdrawals at their marginal rate.
- Expression of wishes forms direct (but do not legally bind) where DC pension death benefits go.
Key Facts
What Happens to a DC Pension When You Die?
When the holder of a defined contribution (DC) pension dies, the remaining pension pot does not automatically form part of their estate in the same way as other assets. Under the current rules (which apply until 5 April 2027), the pension trustees decide who receives the death benefit based on a combination of the member expression of wishes and the trustees discretion. Because the trustees have discretion, the pension benefits technically do not form part of the member estate and are currently not subject to inheritance tax.
The tax treatment of the payment to the beneficiary depends on whether the member died before or after age 75. If the member dies before age 75, beneficiaries can receive the pension pot as a lump sum or as an income completely free of income tax. If the member dies after age 75, beneficiaries pay income tax on any withdrawal at their marginal income tax rate, as if the pension income were their own earned income.
The April 2027 Change: DC Pensions and IHT
The Autumn 2024 Budget announced that from 6 April 2027, unused DC pension funds will be included in the deceased member estate for inheritance tax purposes. This is the most significant change to pension death benefit rules since the introduction of Pension Freedoms in 2015. Under the new rules, the value of any unspent DC pension pot at death will be added to the rest of the estate (property, investments, savings, and other assets) and IHT will be assessed on the total above the available nil-rate band.
The IHT nil-rate band is 325,000 pounds per person. The residential nil-rate band adds up to 175,000 pounds where a property passes to direct descendants. A married couple can combine their nil-rate bands, giving a combined allowance of up to 1 million pounds where the full residential nil-rate band applies. IHT is charged at 40% on the value of the estate above the available threshold.
For estates where the combined value of other assets plus the pension pot exceeds the nil-rate band, the IHT on the pension component will be charged at 40% on the excess. The government intends to collect IHT on the pension portion and then the remaining pension proceeds will pass to the beneficiary, subject to income tax as under the current rules (tax-free if the member died before 75, taxed as income if after 75). The interaction of IHT and income tax on the same pension pot creates a potential double tax scenario for larger estates, which is generating significant planning discussions in the financial adviser community.
Spouse and Civil Partner Exemption
Transfers between spouses and civil partners are generally exempt from IHT regardless of the value. DC pension death benefits paid to a surviving spouse or civil partner are expected to remain exempt from IHT under the 2027 changes, consistent with the general spousal exemption that applies to other assets. The surviving spouse would then be subject to IHT on the pension when they die, at which point their own nil-rate band applies.
The income tax treatment of pension benefits passed to a spouse is unchanged: free of income tax if the member died before 75, taxable as income at the spouse marginal rate if after 75.
Expression of Wishes
Every DC pension holder should complete an expression of wishes (also called a nomination of beneficiaries) form, held by the pension provider or trustees. This form names who the member wishes to receive the death benefits. The trustees are not legally bound by the expression of wishes but almost always follow it in straightforward family situations. Keeping the expression of wishes up to date is important: an outdated nomination naming an ex-spouse or a deceased parent could result in benefits being paid incorrectly.
Because the trustees have discretion, the nomination does not constitute a binding direction and the pension benefits do not become part of the member estate solely because a beneficiary is named. This discretionary structure is the mechanism that has historically kept DC pensions outside the IHT estate. The April 2027 change overrides this position by statute, bringing pension funds into the IHT calculation regardless of the discretionary structure.
Defined Benefit Pension Death Benefits
Defined benefit (DB) pension death benefits operate under different rules from DC pensions. For an active member who dies in service, the typical benefit is a lump sum (often 4 times salary or more) plus a dependant pension for a spouse or civil partner. For a deferred member who has left the employer but not yet drawn their pension, the benefit is typically a return of contributions or a reduced deferred pension for the dependant. For a pensioner member who is already drawing their pension, the benefit depends on the scheme rules, commonly a spouse pension at 50% of the member pension for life and potentially a guarantee period on the lump sum element.
Frequently Asked Questions
Is a pension included in my estate when I die?
Currently (until 5 April 2027) no: DC pension pots are not included in the estate for IHT purposes. From 6 April 2027, unused DC pension funds will be included in the estate and potentially subject to IHT at 40% above the nil-rate band.
Does my spouse inherit my pension tax-free?
Transfers to a spouse or civil partner are generally IHT-exempt. Income tax on the pension withdrawal depends on whether you died before or after age 75: before 75, your spouse receives it income tax-free; after 75, they pay income tax at their marginal rate on withdrawals.
What is an expression of wishes form?
A form held by your pension provider naming who you wish to receive your pension death benefits. The trustees use this as guidance but are not legally bound by it. Keep it up to date, especially after life events such as marriage, divorce, or bereavement.
What happens to my pension if I die before 75?
Under current rules, your nominated beneficiaries can receive the pension pot as a lump sum or income completely free of income tax. From April 2027, the pot may also be subject to IHT depending on the total estate value, but the income tax-free status for under-75 deaths is not expected to change.
