How to Include Pensions in Estate Planning

Pensions are a key part of many people's financial planning and can represent a significant element of what is passed on after death. Unlike many other assets, pensions have specific legal and tax characteristics that influence how they are treated on death, who can inherit them, and what estate planning steps you should take. This article explains how pensions fit into estate planning in England and Wales, including legal rules, tax implications, nominations, practical steps and how upcoming changes affect planning.

1. The Role of Pensions in an Estate

Estate planning involves organising how your assets will be distributed when you die. In England and Wales, pensions are treated differently from most other assets such as property, bank accounts or investments. Many UK pension schemes allow death benefits to pass outside a will, directly to chosen beneficiaries. However, recent and forthcoming changes to inheritance tax (IHT) law mean that pensions must be considered carefully in any comprehensive estate plan. Planning helps ensure your pension benefits are directed to the people or organisations you want, minimises tax where possible, and avoids confusion or delays for your estate representatives.

2. Types of Pension and What Happens on Death

2.1 Private and Workplace Pensions

Pension plans come in various forms, including employer‑sponsored workplace pensions and personal pensions such as self‑invested personal pensions (SIPPs). When a pension holder dies, the remaining pension fund may pay death benefits to nominated beneficiaries. These can include lump sums or continuing income, depending on the scheme's rules and the age at death.

Pensions are separate from other estate assets and, in many cases, pass outside a will. Pension providers usually distribute death benefits under the terms of the pension scheme rather than through the will process.

2.2 Defined Contribution vs Defined Benefit

• Defined contribution schemes: These have a money‑purchase pot that can often be passed to nominated beneficiaries as a lump sum or via drawdown.
• Defined benefit schemes (sometimes known as final salary or career average): These typically provide ongoing income to dependants, known as dependant's pensions. The available death benefits depend on scheme rules.

2.3 State Pension

State Pension generally does not pass to beneficiaries when you die, although under certain circumstances a spouse or civil partner may receive some additional amount. This article focuses on private and workplace pensions.

3. Nominating Beneficiaries for Pension Death Benefits

3.1 Expression of Wish Forms

Most pension schemes ask members to complete an expression of wish or nomination form to tell the pension provider who should receive death benefits. Although such forms may not be legally binding, the trustees or scheme administrators usually take them into account when exercising discretionary powers. Updating this form regularly ensures beneficiaries reflect your current intentions.

If you do not complete a nomination, the scheme's rules determine who receives benefits, which may lead to outcomes that differ from your wishes.

3.2 Discretionary vs Directed Payments

Where pension trustees have discretion to decide who receives death benefits, the benefits are typically not treated as part of your estate for tax purposes under current rules. However, if you can direct payment to specific beneficiaries or make a binding nomination, the death benefits can be considered part of your estate for tax purposes under the new rules from April 2027.

4. Tax Treatment of Pensions on Death

4.1 Income Tax on Death Benefits

Whether beneficiaries pay income tax on pension death benefits depends on the age of the pension member at death and the form of benefit. Under current UK rules:

• Before age 75: Lump sum and drawdown benefits are usually paid tax‑free to beneficiaries, provided they are paid within specified time limits.
• After age 75: Benefits are normally taxed at the beneficiary's marginal rate of income tax.

The specific tax treatment can vary with scheme rules and benefit types.

4.2 Inheritance Tax (IHT) - Current and Future Rules

Historically, unused pension funds and death benefits in the UK were usually exempt from inheritance tax because they were held in trust and payable at the discretion of pension trustees. This meant they did not count towards the estate value for IHT. However:

• From 6 April 2027, most unused pension funds and death benefits will be included in the value of an individual's estate for inheritance tax purposes. This change reforms the law to align pensions with other estate assets for IHT and applies to defined contribution pensions and many schemes where death benefits are paid.
• Death in service benefits and certain defined benefit scheme pensions remain excluded from IHT.
• Spouses, civil partners and registered charities still benefit from exemptions where pensions pass to them.

Under the new regime, executors (personal representatives) are responsible for reporting and paying IHT on pensions included in the estate. Pension scheme administrators also have new duties to support this process.

5. Estate Planning Steps for Pensions

5.1 Regularly Update Nominations

Keep beneficiary nomination forms current, particularly after major life events such as marriage, divorce, births or deaths in the family. An up‑to‑date expression of wishes helps ensure that pension death benefits are distributed in line with your intentions.

5.2 Coordinate with Your Will

Although pensions often pass outside wills, you should still coordinate your pension nominations with your overall estate strategy. A will can direct other assets to the same beneficiaries and clarify your broader intentions.

5.3 Consider Tax Changes After 2027

With pensions due to be included in the inheritance tax calculation from April 2027, review your estate plan to assess how this change affects your overall tax position. This may involve:

• Reviewing pension values in the context of your estate's total value.
• Considering making lifetime pension withdrawals or gifts if appropriate and affordable.
• Updating nominations to align with family and tax planning objectives.

5.4 Professional Advice

Pension and estate planning is technical and intersects with tax, trusts and family law. Seek guidance from a solicitor or financial adviser who understands the implications of the forthcoming changes and how they interact with your circumstances.

6. Time Limits and Administrative Considerations

When a pension member dies, the person dealing with the estate (such as an executor or personal representative) should notify the pension provider promptly. Tax reporting deadlines apply: for example, HMRC must be informed of pension benefits and any tax due within specified periods (often 13 months). This administrative work forms part of the estate's final accounting and ensures compliance with legal and tax obligations.

7. Common Questions About Pensions in Estate Planning

Do pensions form part of the estate?
Under current rules, most pension schemes hold death benefits outside the estate because trustees exercise discretion. But from 6 April 2027, most unused pension funds and death benefits will be included in the estate for inheritance tax purposes even if they are discretionary.

Can I choose who inherits my pension?
Yes: you can complete a beneficiary nomination or expression of wishes form with your pension provider. Trustees usually consider these wishes when paying death benefits.

Will my beneficiaries pay tax on pension death benefits?
If the member dies before age 75, death benefits are generally paid tax‑free. After age 75, beneficiaries usually pay income tax at their marginal rate on amounts they receive. Future inclusion in IHT may also affect the overall tax burden.

What about state pensions?
State Pension generally ends on death and does not pass on to beneficiaries, except in very limited circumstances under specific rules.

Key Takeaways

Pensions play a unique role in estate planning in England and Wales. Key points include:

• Pension death benefits are usually paid to nominated beneficiaries, often outside a will, based on scheme rules.
• Completing and updating beneficiary nomination or expression of wish forms ensures benefits are directed as you intend.
• Tax treatment varies by age and type of benefit, with income tax possible for beneficiaries and significant changes to inheritance tax rules from 6 April 2027.
• Coordinating pension planning with your wider estate plan, including wills and tax planning, helps protect your legacy and manage tax liabilities.
• Professional advice is invaluable given the complexity of pension law and upcoming IHT changes.