How Children Can Inherit Your Pension in the UK: Tax Rules & Claiming Process Explained

Yes, your children (or other beneficiaries) can inherit your pension if you pass away, and the rules for claiming the pension and whether they pay any tax on it depend on your age at the time of your death and the type of pension scheme you have. Here's a detailed explanation of how it works in the UK:

1. Workplace Pension or Personal Pension (Defined Contribution Pension)

If you have a defined contribution pension (most modern workplace pensions or personal pensions), your pension pot is invested and grows over time. Upon your death, the remaining pension pot can usually be passed on to your beneficiaries, such as your children or spouse. Here's what happens:

a) Nominating a Beneficiary

You can nominate one or more beneficiaries (e.g., children, spouse, partner) to inherit your pension. You typically do this by filling out a "nomination of beneficiary" form with your pension provider. If you haven't done this, the pension provider may distribute the funds according to your will or their rules.

b) How Your Children Can Claim Your Pension

The way your beneficiaries (such as your children) can access the pension depends on the provider's rules, but in general, they will have the option to:

Take a lump sum payment.
Receive regular income through a pension drawdown (continuing to take out money gradually).
Purchase an annuity for a guaranteed income.

c) Tax Implications

The amount of tax your children pay depends on your age at the time of your death:

If you die before age 75:
- Tax-free: Your children or beneficiaries can inherit the pension pot tax-free, whether they take it as a lump sum or in regular payments, as long as the pension is claimed within two years of your death.
If you die at age 75 or older:
- Subject to income tax: Any money withdrawn from the pension by your children or beneficiaries will be taxed at their marginal rate of income tax (the same as if it were income). For example:
  - If your child is a basic-rate taxpayer (earning up to £50,270), they will pay 20% tax on the amount they withdraw.
  - If they are a higher-rate taxpayer (earning between £50,270 and £125,140), they will pay 40% tax.
  - If they are an additional-rate taxpayer (earning over £125,140), they will pay 45% tax.

Example:

If you pass away before age 75 and your pension pot is £200,000, your children could receive the entire £200,000 tax-free if they claim it within two years.
If you pass away after age 75, and your child earns £30,000 per year, they could withdraw some or all of the £200,000 pension pot, but it would be taxed at 20% (their income tax rate) on any withdrawals, because it would be considered additional income for that year.

2. Defined Benefit Pension (Final Salary Pension)

A defined benefit pension (often called a final salary pension) works differently because it provides a guaranteed income for life rather than a pension pot that can be inherited. However, there are still death benefits:

If you die before retirement: Many defined benefit schemes will pay a lump sum (often a multiple of your salary, such as 2-4 times your salary) to your nominated beneficiaries. They may also provide a pension for a spouse or dependent children (e.g., 50% of what your pension would have been).
If you die after retirement: The pension will usually stop upon your death, but a reduced pension may be paid to your spouse or dependent children (e.g., 50% of your pension). The exact amount and who qualifies will depend on the rules of the scheme.

3. Inheritance Tax (IHT) on Pensions

Pension funds are not usually subject to inheritance tax (IHT). This is one of the major advantages of leaving a pension to your beneficiaries compared to other assets. However:

If you don’t nominate a beneficiary and the pension is paid to your estate, it could potentially be subject to inheritance tax (which is charged at 40% on estates over the threshold of £325,000).

4. When Can Your Children Claim Your Pension?

Timing: Your children can claim the pension as soon as they provide proof of your death and complete the necessary paperwork with your pension provider. If you die before age 75, they need to claim within two yearsto receive the pension tax-free.
Flexibility: They can choose whether to take a lump sum or receive regular payments, depending on the pension provider's options.

5. Steps to Ensure Your Pension Goes to Your Children

Nominate Beneficiaries: Make sure you’ve nominated your children (or whoever you want) as beneficiaries with your pension provider. This is often referred to as an Expression of Wish or Nomination of Beneficiaries form.
Update Regularly: Update your nomination regularly, especially if your personal circumstances change (e.g., marriage, divorce, new children).
Pension Pot Growth: Keep an eye on the growth of your pension pot over time, and consider contributing more while you’re still working, as the more you contribute, the more your beneficiaries may receive.

6. Important Considerations

Pension Type: Check whether your pension is a defined contribution or defined benefit, as the inheritance rules vary between the two.
Age: The tax treatment depends on your age at death, so it’s important to inform your children about the rules if they ever need to claim your pension.
Beneficiary Details: Ensure the pension provider has up-to-date beneficiary details and that you’ve clearly specified how the pension should be distributed.

Summary:

Your children can inherit your pension pot if you pass away, and the tax treatment depends on whether you die before or after age 75.
If you die before 75, your children can inherit the pension tax-free.
If you die after 75, any withdrawals will be taxed at your children's income tax rate.
Inheritance tax usually doesn’t apply to pensions, provided you’ve nominated beneficiaries.

To ensure that your pension passes smoothly to your children, be sure to nominate them as beneficiaries and review this periodically. It’s a tax-efficient way of passing on wealth, as pensions often avoid inheritance tax.