Inheritance of Pension funds

se2020

Adult children stand to inherit some funds from a deceased parents pension. 

Parent was over 75.

My understanding is,
The pension does not form part of the deceased estate for IHT.
The children pay income tax on the funds recived at the corresponding tax rates. (These vary from 20%to 40%)

Can the children avoid paying this tax?
Legitimate ways obviously. 

If the children do not have any form of existing pension could they have the funds transfered directly into a new pension to matain tax free status?

If they already have a workplace pension could funds be transferred into that?

The options offered by the pension provider seem to suggest the funds can be paid out as a lump sum or paid in smaller amounts over an (unmentioned length) timeframe.
Could the 40% rate payers leave the funds unclaimed until they retire themselves (20yrs?) and only withdraw when they drop to a lower tax rate?

Or, could they claim the funds, pay the relevant tax, then pay the full amount into a new pension claiming the equivalent relief?
Ie  in the case of the 40% payer it would make sense to do that now while they are still in the 40% bracket.

I am aware that from 2027 pensions may well form part of the estate for IHT. Will that happen to any unclaimed funds in this case or not as the death was in 2025?

Thanks!

SadCodeMan

I think their ability to keep the money within the wrapper will depend on what the scheme offers.

I think there is no reason why they could not take sums from the scheme and reinvest it in their own one though.
It looks from the below link as if this does not trigger recycling or MPAA restrictions

https://techzone.aberdeenadviser.com/public/pensions/tech-guide-recycle-tax-free-cash#:~:text=Pension income recycling,-Individuals can recycle&text=But there's an additional restriction,flexibly without triggering the MPAA.

They would need to have sufficient relevant earnings to cover what they were going to invest though I think. But, if they aer 40% payers and this is from earnings then I am guessing this wont be an issue.

It will, of course, limit the other payments they might have been making so the total does not go above 60K (current).

This would have the additional restriction that the new pension would only be available to them after the age of 57 though (or whatever that becomes) rather than being able to access now so something to think about.

Given the 2027 changes, if they are not already fully using ISAs it might just possibly be sensible to use those to the max? Even if that was just a holding pen to keep the taxed money before investing larger lump sums into pension closer to the time? If they were still higher tax payers, other than the investment limits, the result would be the same but the flexibility could be greater.

All this may change at the end of the month... and future years...

You can never say never about what might change in the future (2027 for example) but I would be absolutely stunned if they made a retrospective IHT charge for someone who had already died. That would cause such a stink I don't think they would be able to do it (or would want to try).

Keep_pedalling

se2020 said:

Adult children stand to inherit some funds from a deceased parents pension. 

Parent was over 75.

My understanding is,
The pension does not form part of the deceased estate for IHT.
The children pay income tax on the funds recived at the corresponding tax rates. (These vary from 20%to 40%)

Can the children avoid paying this tax?
Legitimate ways obviously. 

If the children do not have any form of existing pension could they have the funds transfered directly into a new pension to matain tax free status?

They could do, it will still be subject to tax when the money is drawn down and bossible be subject to IHT on their own estates if they don’t use it before they die.

If they already have a workplace pension could funds be transferred into that?

Depends on the rules of the scheme but unlikely. 

The options offered by the pension provider seem to suggest the funds can be paid out as a lump sum or paid in smaller amounts over an (unmentioned length) timeframe.
Could the 40% rate payers leave the funds unclaimed until they retire themselves (20yrs?) and only withdraw when they drop to a lower tax rate?

Again this depends on the rules of  pension scheme of the deceased but that is unlikely to be an option.

Or, could they claim the funds, pay the relevant tax, then pay the full amount into a new pension claiming the equivalent relief?
Ie  in the case of the 40% payer it would make sense to do that now while they are still in the 40% bracket.

The amount you can pay into a pension limited by how much income you have. For instance if you were unemployed you are limited to paying in £2880 pa.

I am aware that from 2027 pensions may well form part of the estate for IHT. Will that happen to any unclaimed funds in this case or not as the death was in 2025?

Thanks!

Changes to IHT rules only effect estates where the deceased died after the implementation of the new rules.

Smudgeismydog

Can’t they just transfer the inherited pension into a pension in their own name? As @keep_pedalling noted, it will be chargeable to income tax at their marginal rate when they draw it down. However, they could draw down in their interim period between retiring and accessing e.g State pension, to keep their liability to income tax as low as possible. 

se2020

Smudgeismydog said:

Can’t they just transfer the inherited pension into a pension in their own name? As @keep_pedalling noted, it will be chargeable to income tax at their marginal rate when they draw it down. However, they could draw down in their interim period between retiring and accessing e.g State pension, to keep their liability to income tax as low as possible. 

This is what I was asking?
The funds recived will all be taxed at nominal rate for each child.
Then, if the same amount is transferred back into a new pension they each create they should get the equivalent in tax relief. 

Ie, basically the same as paying no tax on it.

There are 20% and 40% rate paying children,  the amounts involved would not exceed annual earned income (or 60k).

2 of the children have workplace pensions so I am not sure if the contributions from those count towards the annual income/60k limit?
But, if they do, presume the funds could be partially claimed each year.

Or are there any other/better ways to reduce the amount of tax owed?

se2020

Just tried using a pension tax relief caculator and I'm not sure this will work for the 40% payers if they do not have high enough incomes.

If the pension inheritance is £24k
That will be taxed at 40% leaving £14,400.

Pay £14,400 into a new pension and get 20% added giving £18k.
Then someone earning £75k can only claim another £3600 in extra tax relief.
So a total of £21,600

Should work ok for the 20% payers though?

Smudgeismydog

No, I’m not suggesting take it out of the pension and then putting it back in as a contribution. If they inherit and transfer into their pension, it is not a new contribution, so doesn’t attract tax relief (as it’s already received this via the original recipient). 

Daniel54

I agree with Smudge.Hold the inherited pension(s) in a flexi access drawdown wrapper and then draw down over time and as appropriate.

I would not co-mingle with an existing pension as the inherited pension does not permit a tax free lump sum on crystallization.

There is no need or requirement to take as a lump sum in one go.

se2020

Thanks!
I'll have a closer look at the existing pension and see what options it offers

se2020

Smudgeismydog said:

No, I’m not suggesting take it out of the pension and then putting it back in as a contribution. If they inherit and transfer into their pension, it is not a new contribution, so doesn’t attract tax relief (as it’s already received this via the original recipient). 

This makes sense.
But,
Say a 20% rate paying child already has £20k of own funds in a bank account. Earns £35k/Yr.

They inherit £25k from the parents pension.
Pay £5k of that in tax.
Keep the remaining £20k.

Pay the £20k they had before into a new pension in own name and get 20% tax relief on that.
End up with £24k in a pension and still have £20k in the bank.
Effectively reducing the tax on the inheritance to £1k and enabling them to take 25% out, tax free, at 58.

Although,  if they want the money to go into a pension and they can keep it in the existing wrapper or transfer into a suitable alternative while keeping the full amount that would obviously be preferable. 

jem16

se2020 said:

Smudgeismydog said:

No, I’m not suggesting take it out of the pension and then putting it back in as a contribution. If they inherit and transfer into their pension, it is not a new contribution, so doesn’t attract tax relief (as it’s already received this via the original recipient). 

This makes sense.
But,
Say a 20% rate paying child already has £20k of own funds in a bank account. Earns £35k/Yr.

They inherit £25k from the parents pension.
Pay £5k of that in tax.
Keep the remaining £20k.

Pay the £20k they had before into a new pension in own name and get 20% tax relief on that.
End up with £24k in a pension and still have £20k in the bank.
Effectively reducing the tax on the inheritance to £1k and enabling them to take 25% out, tax free, at 58.

Although,  if they want the money to go into a pension and they can keep it in the existing wrapper or transfer into a suitable alternative while keeping the full amount that would obviously be preferable. 

That isn’t correct. If you pay £20k into a pension, then 25% is added so £5k and you now have £25k in the pension. 

But what would be the point in doing that? You still end up in the same position as if you’d just transferred the pension to your own name.