Did you know that pensions can be a tax-efficient way to pass on wealth? It’s because most people won’t have to pay inheritance tax on a SIPP they inherit.
In this guide we take a closer look at SIPP inheritance tax. We also answer common questions like, “who works out the tax due on a SIPP?” and “what happens if the beneficiary dies before drawing on a pension?”.
What is inheritance tax?
When someone dies, inheritance tax is a tax due on assets owned when they die. However, generous tax-free allowances mean that many people don’t have to pay any inheritance tax.
The nil rate band (tax-free allowance) is currently £325,000 for a single person and they may get an extra £175,000 residence nil rate band if they own a property. Any taxable assets worth more than a person’s nil rate band will often incur a 40% tax charge.
Self-invested personal pensions (SIPPs) are usually outside the pension owner’s taxable estate. SIPP inheritance tax is only charged in very rare circumstances. In most cases, a SIPP is therefore inherited with no inheritance tax to pay.
What happens to my SIPP when I die?
If you have funds in your SIPP when you die then these can be passed on to a beneficiary. You can nominate anyone you choose and you can also split your SIPP between various beneficiaries. If you haven’t chosen a pension beneficiary then your pension trustees will be responsible for deciding what happens to your SIPP.
The person who receives your pension can choose whether to receive the pension as a lump sum or draw an income. The amount of tax due will depend on your age when you die and the type of pension.
What happens when I inherit a SIPP?
When you inherit a SIPP you will usually be informed by the pension trustees.
You should take financial advice as you may have several options for how to access your pension. A financial adviser will be able to advise you on the best option for you and how to minimise your income tax bill.
How much is SIPP inheritance tax?
Inheritance tax isn’t usually due on an inherited pension as it is excluded from the taxable estate. This is a big potential tax saving compared with other inherited assets.
Inheritance tax on an estate is 40% on amounts over the nil rate band. A single person gets a tax-free nil rate band of £325,000 and they may get an extra £175,000 residence nil rate band if they own a property and pass it on to their children or grandchildren.
For example, Janet has never married and owns a house worth £600,000 and has a pension pot she hasn’t used of £200,000. She dies and passes her estate to her son. The taxable estate is only £600,000 as the pension is excluded. Janet has a nil rate band of £500,000 (£325,000 + £175,000). £100,000 of her estate will be taxed at 40% so there will be £40,000 inheritance tax to pay.
Inheritance tax may be due on a pension in certain rare circumstances, for example when the deceased made changes to their scheme within 2 years of death. That’s why it’s a good idea for executors to take professional advice to make sure all tax liabilities are paid.
What about income tax?
Income tax may be due on an inherited pension, depending on the age of the deceased person and the type of pension scheme.
If the pension owner was under 75 when they died you may have to pay income tax if the following applies:
The pension was an old type of drawdown fund
You receive the pension more than 2 years after the pension provider was informed of the death
The pension was worth more than the lifetime allowance, currently £1.073 million
If the pension owner died when they were over 75 then you may have to pay income tax on your pension income.
Rules for income tax on an inherited pension are complex so it’s a good idea to get financial advice. How you draw a pension may affect the tax payable.
How much is SIPP inheritance tax?
Inheritance tax isn’t usually due on an inherited pension as it is excluded from the taxable estate. This is a big potential tax saving compared with other inherited assets. Inheritance tax of 40% is charged on the taxable portion of some bigger estates.
What if my SIPP is not taxed, can those benefiting be at fault?
You should get professional advice from a solicitor or financial adviser if you inherit a pension. They will make sure that any tax is paid in full and on time. If you don’t pay any inheritance tax or income tax owed then you or the executors of the estate may be liable in the future.
Does my SIPP have any death benefits?
Your SIPP allows you to pass on any unused pension when you die. This is usually free of inheritance tax and is often free from income tax if you die before you are 75 years old.
Is my pension protection lump sum tax free?
When you buy an annuity many providers offer a guaranteed lump sum if you die within 5 to 10 years of buying the annuity. This is usually paid tax free if you die before you are 75, but will attract income tax if you die after you are 75 years old.
What are the SIPP inheritance tax rules if I have taken an annuity?
If you have bought an annuity then the rules will be set out in your terms and conditions. Some annuities stop at death and others pay out an income or a lump sum to a survivor. You should take financial advice to see if inheritance tax is due on your annuity. It will depend on the type of pension scheme and if the pension owner was over 75 when they died.
What are the new SIPP inheritance rules?
Under the new SIPP inheritance rules you may be able to inherit a pension without having to pay any tax if the pension owner dies before they are 75 and the funds are transferred or designated within 2 years.
Inheritance tax and income tax may still be due in certain circumstances so you should get financial advice.
I’m a great believer in investing in a pension to build long-term wealth. You’ll get generous tax breaks when you pay money into your pension. Not only that, but most people can pass on any money left in their pension when they die with no inheritance tax to pay. If you die before you’re 75 then the person who inherits your pension will probably also have no income tax to pay.
Book an appointment to see a financial adviser if you want to minimise your inheritance tax bill. The rules are complicated and vary depending on your circumstances.
Bottom line
Most people who inherit a pension will have no inheritance tax to pay. It means that, for many people, pensions can be a tax-efficient way to pass on wealth to the next generation. There may also be no income tax to pay if the pension owner dies before they are 75 years old.
It’s worth speaking to a financial adviser to find out more about your tax position. Some older schemes and changes to your pension within 2 years of death could result in a tax charge.
Frequently asked questions
You won’t usually need to pay inheritance tax on a SIPP you inherit. However you should take professional advice as tax rules are complex and tax may be owed in some rare circumstances.
Many people use a probate solicitor to administer an estate after someone has died. It is their responsibility to work out any inheritance tax due on the estate and make sure it is paid on time.
In most cases SIPPs will not be part of your taxable estate when you die. This means your beneficiaries won’t be charged inheritance tax on a pension pot they inherit.
However, there are some exceptions when inheritance tax may be due, such as when the deceased made changes to the pension scheme within 2 years of their death. It makes sense for your executors to get professional advice as they are responsible for making sure that all tax is paid.
If the beneficiary dies and there are still funds in the pension then they can pass it on to their nominated beneficiary. The same rules will apply as if they had originally owned the pension.
Inheritance tax is not usually payable on pension funds as long as they are registered as a pension scheme. Investment property or other assets you are using for retirement income may be subject to inheritance tax.
Your SIPP is not usually part of your taxable estate, although the beneficiaries may owe income tax on any income received, depending on the circumstances.
You can inherit your parent’s SIPP if they haven’t used up all the funds and you are a nominated beneficiary.
If you don’t nominate a beneficiary then the pension trustees will choose a beneficiary who will usually be a financial dependant.
The inheritance tax nil rate bands are frozen until 2026. This will not affect inheritance tax due on most inherited SIPPs as they fall outside the taxable estate.
Pensions are long-term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply. Keep in mind that the tax treatment of your pension and investments will depend on your individual circumstances and may change in the future. Capital at risk.
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The tax you need to pay depends on your individual circumstances and can change over time. This content is for information only - it's not tax advice. You're responsible for carrying out your own checks and for getting professional advice before making financial decisions.
Alice Guy is a Suffolk-based finance writer, a busy mum of 4 older kids and a self-confessed personal finance geek. She trained as a chartered accountant with KPMG London before working for Tesco Plc as a business analyst. She loves to write about budgeting, saving, investing and building wealth. See full bio
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