Tax on Pension Death Benefits

When you inherit someone's pension, the tax you pay depends on how old they were when they died, what type of payment you receive, and how quickly the pension is paid out. If the pension holder was under 75, you may pay no tax at all — but there are important allowances and time limits to be aware...

How tax on inherited pensions works

The tax treatment of pension death benefits depends primarily on whether the deceased was under or over 75 when they died.

If the deceased was under 75:

Most lump sum payments are tax-free, as long as they're paid within 2 years of the pension provider being told about the death and don't exceed the lump sum and death benefit allowance. Income from a new drawdown fund (set up or converted and first accessed from 6 April 2015 onwards) or an annuity is also tax-free.

If the deceased was 75 or over:

All payments — whether lump sums or regular income — are subject to Income Tax. The pension provider will deduct tax before paying you.

The lump sum and death benefit allowance

For deaths where the pension holder was under 75, there's a key allowance to consider: the lump sum and death benefit allowance.

This allowance is £1,073,100 for most people. However, it could be higher if the deceased had protected allowances from previous pension rules.

If the total lump sum death benefits paid from all the deceased's pension schemes exceed this allowance, you'll pay Income Tax on the excess. The rate depends on your own marginal tax rate — the tax band you fall into based on your total income for the year.

Types of death benefit payments

Different types of pension payment have different tax rules:

Lump sums from defined contribution or defined benefit pensions:

Tax-free if the deceased was under 75 (subject to the allowance and 2-year rule)
Taxed as income if they were 75 or over

Annuities or money from new drawdown funds:

Tax-free if the deceased was under 75
Taxed as income if they were 75 or over

Money from old 'capped' drawdown funds (first accessed before 6 April 2015):

Taxed as income regardless of the deceased's age

Trivial commutation lump sums:

Taxed as income regardless of the deceased's age

Regular pension income provided by the scheme:

Always taxed as income, regardless of age

When you might pay tax on an under-75 death benefit

Even if the deceased was under 75, you may still face a tax charge if:

The lump sum is paid more than 2 years after the pension provider is told of the death
The total lump sum death benefits exceed the deceased's lump sum and death benefit allowance
The deceased died before 3 December 2014 and you buy an annuity from the pot

In these cases, you'll pay Income Tax at your marginal rate on the taxable amount.

Reporting requirements for executors and legal representatives

If you're dealing with someone's estate and lump sum death benefits exceed the deceased's lump sum and death benefit allowance, you must tell HMRC. This only applies when the deceased was under 75.

You must report within 13 months of the death or 30 days after you realise tax is owed, whichever is later.

To report a lump sum death benefit charge, you'll need to complete an online form and send the details to HMRC. You'll need:

Your name, address and contact details
The deceased's date of birth, date of death, National Insurance number, and details of any protected allowances
Details of all the deceased's pension schemes
For each beneficiary: their name, date of birth, address, National Insurance number, and the total benefits received

Once HMRC receives this information, they'll calculate the tax charge based on each beneficiary's marginal tax rate. They cannot raise charges until after the tax year has ended, because they need to know each beneficiary's total income to work out their marginal rate.

HMRC will send each beneficiary a notice by post showing what they owe and a 14-character charge reference for making payment. Beneficiaries can appeal in writing within 30 days if they disagree with the charge.

Claiming tax refunds

If you've paid too much tax on a pension death benefit, you can claim a refund.

If you complete a Self Assessment tax return each year, you'll get any refund after you submit your return.

If you don't complete Self Assessment, you'll need to claim using a specific form. The form you use depends on whether:

The payment used up the whole pension pot and you have no other income in the tax year
The payment used up the pension pot and you have other taxable income
The payment didn't use up the pension pot and you're not taking regular payments

Inheritance Tax

You don't usually pay Inheritance Tax on pension death benefits because payment is normally 'discretionary' — meaning the pension provider can choose whether to pay it to you.

Ask the pension provider whether the payment was discretionary. If it wasn't, you may need to pay Inheritance Tax on the amount received.

Who can inherit a pension

The person who died will usually have nominated you to their pension provider. Sometimes the provider can pay the money to someone else if the nominated person cannot be found or has died.

Pensions from defined benefit schemes can usually only be paid to a dependant — such as a spouse, civil partner, or child under 23. They can sometimes be paid to someone else if the scheme rules allow it, but this will be taxed at up to 55% as an unauthorised payment.

If you inherit a defined contribution pension pot, you can nominate someone to receive any money you don't use before your death. The money must be in a flexi-access drawdown fund when you die.

Sources

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.