How to Plan for Pension Benefits

Planning for pension benefits is a vital part of any comprehensive estate plan. Pensions can represent a substantial portion of an individual's wealth, and the way they are handled on death can have legal, financial and tax consequences for beneficiaries. Recent reforms mean that the inheritance tax treatment of pension funds is changing, making early planning more important than ever. This guide explains the legal framework for pension benefits in England and Wales, outlines key steps to help protect and direct your pension on death, and answers common questions about rights, processes and risks.

Introduction to Pensions and Estate Planning

In England and Wales, pension schemes are regulated and tax‑advantaged products designed primarily to provide retirement income. They include workplace pensions, personal pensions and defined benefit arrangements. On death, the value of a pension or associated death benefits may be payable to nominated beneficiaries, dependants or, in some cases, the deceased's estate. Understanding how this works and planning for it helps ensure that your pension benefits are distributed in accordance with your wishes and that beneficiaries receive the maximum possible financial benefit.

Most pensions have death benefit provisions separate from the will and the general estate. Currently, many schemes operate on a discretionary basis, meaning trustees decide who receives the benefits and how they are paid. Where trustees exercise discretion, benefits typically fall outside the estate for inheritance tax (IHT) purposes. However, significant changes to the IHT treatment of pensions will take effect from 6 April 2027, bringing most unused pension funds and death benefits into the value of the estate for IHT purposes.

Pension Death Benefits: What They Are and Who Can Inherit

How Pension Death Benefits Work

When a pension saver dies, their pension scheme may pay out a death benefit. These can be:

• A lump sum – a single payment made to beneficiaries.
• A dependant pension – ongoing income paid to a spouse or partner.
• A beneficiary pension – an inherited pension account that beneficiaries can draw from.

Death benefits arise from the terms of the pension scheme, not automatically under a will. Different pensions operate under different rules:

• Defined benefit schemes (final salary) usually provide specific benefits for dependants laid down by scheme rules.
• Defined contribution schemes (money purchase) often allow the member to nominate beneficiaries using an expression of wish form. Trustees usually take this into account when exercising discretion.

Beneficiaries and Nominations

You can normally nominate one or more beneficiaries (often family members or others) to receive your pension death benefits. Schemes use an expression of wish form to record this. These nominations are usually not legally binding, but trustees generally follow them unless there are compelling reasons not to.

It is important to update nominations after major life events such as marriage, divorce, births or deaths in the family to ensure your current intentions are reflected.

Inheritance Tax Treatment of Pension Benefits

Current Position and Reforms

Historically, most pension death benefits were not counted as part of a deceased's estate for inheritance tax purposes. This meant that where discretion was retained by trustees, unused pension funds could pass to beneficiaries without increasing the taxable value of the estate.

This treatment helped make pensions a tax‑efficient way to transfer wealth. However, legislation changes taking effect on 6 April 2027 will alter this treatment for deaths on or after that date. From then on:

• Most unused pension funds and death benefits will be included in the deceased's estate for IHT purposes.
• Executors (personal representatives) will be responsible for reporting and paying any IHT due on pension death benefits as part of the estate administration.
• Some exceptions will remain, such as death in service benefits from defined benefit schemes.

This change is intended to eliminate the use of pensions primarily as tax avoidance vehicles and to align pension funds with the wider IHT regime.

Inheritance Tax Basics

Inheritance tax is charged at 40 % on the value of an estate above the nil‑rate band (currently £325,000). There are additional allowances, including the residence nil‑rate band. Without planning, the inclusion of pension funds in the estate could push the total value above these thresholds.

When pension funds are included in the estate for IHT:

• Executors must value and report these funds to HM Revenue & Customs.
• Beneficiaries may receive a reduced inheritance if tax is payable.
• The available allowances and exemptions should be considered in the context of the wider estate.

Practical Steps to Plan for Pension Benefits

1. Review Your Pension Arrangements

Compile detailed information about all pensions you hold, including:

• The type of scheme (defined contribution or defined benefit).
• The value of the pension pot(s).
• Whether death benefits are payable.
• Existing nominations or expressions of wish forms.

Knowing the detail of each arrangement enables better planning and informed discussions with advisers and beneficiaries.

2. Update Nominations Regularly

Complete or review the expression of wish forms provided by your pension scheme. These guide trustees when deciding who should receive death benefits. Keeping these up to date means trustees are more likely to act in accordance with your intentions.

You should update nominations when personal circumstances change, particularly after marriage, separation, divorce, births or deaths.

3. Understand the Role of Trustees

Trustees of pension schemes often have discretion over how death benefits are paid. This means they may consider nominees, dependants and other factors when making a decision. Because nominations are usually expressions of preference rather than binding directions, clear documentation and regular review are important.

If you want greater certainty in who receives benefits, explore with your scheme whether binding nominations are available, as these can alter the inheritance tax treatment and estate inclusion rules.

4. Integrate Pensions With Your Wider Estate Plan

Your estate plan should reflect your goals for all assets, including property, savings and pensions. This may involve:

• Reviewing your will to ensure it complements pension death benefit arrangements.
• Considering lifetime gifts or transfers to reduce estate value ahead of the 2027 IHT changes.
• Discussing with financial advisers whether pension drawdown or annuity products are appropriate for your circumstances.

5. Prepare for the 2027 IHT Changes

With pensions becoming part of the estate for IHT purposes from April 2027, consider strategies to manage potential tax exposure:

• Evaluate whether to draw down pension funds earlier in retirement, subject to your financial needs and tax consequences.
• Use available exemptions and allowances in IHT planning.
• Coordinate pension planning with other estate planning tools such as trusts and lifetime gifts.

Planning ahead can help reduce the impact of these reforms on your beneficiaries.

Legal Processes and Timeframes

When someone dies and pension death benefits are payable:

1. Notify the pension provider of the member's death as soon as possible.
2. Provide necessary documents such as the death certificate and any nomination forms to the trustees or scheme administrators.
3. Trustees will assess nominations and decide on beneficiaries in accordance with scheme rules.
4. Executors include pension values in the estate's IHT calculation where applicable.
5. Any tax due must be reported and paid to HMRC, typically within six months of the end of the month in which the death occurred. (Note that this deadline has been questioned by peers as potentially challenging for executors in complex cases.)

Common Questions About Pension Planning

Will my pension automatically be included in my estate?

Under current law, pension death benefits may fall outside your estate for IHT if discretionary. From 6 April 2027, most unused pension funds and death benefits will be treated as part of your estate for inheritance tax calculations.

Who decides who receives my pension benefits?

Trustees of your pension scheme usually have discretion. An expression of wish form guides that decision but is typically not binding.

Can I change beneficiaries after I retire?

Yes. You can usually update your nomination forms at any time, subject to scheme rules. Keeping these current ensures trustees consider your most recent intentions.

Do I need a will if I have pension arrangements?

Yes. A will is still essential for assets within your estate. Pensions are typically dealt with separately and do not automatically pass under your will.

Risks and Considerations

• Estate tax exposure: The planned inclusion of pensions in IHT from 2027 means larger estates could face substantial tax bills if not planned carefully.
• Trustee discretion: Because most nominations are non‑binding, trustees may exercise discretion in ways that differ from your expectations.
• Administration deadlines: Executors are required to report and pay tax within tight statutory timeframes, which may be challenging in complex estates.

Key Takeaways

Planning for pension benefits in estate planning is essential in England and Wales, especially in light of upcoming inheritance tax changes effective from April 2027. Key steps include:

• Reviewing all pension arrangements and understanding scheme rules.
• Updating beneficiary nominations regularly.
• Integrating pension planning with your broader estate plan and will.
• Considering strategies to manage the impact of inheritance tax reforms.
• Communicating your intentions clearly to trustees, executors and loved ones.

Early, informed planning can help ensure pension benefits are paid to the people you intend, with appropriate tax and administrative considerations addressed.