When someone dies holding a pension, the money passed on to beneficiaries is subject to its own set of rules that are frequently confused with both Inheritance Tax and Capital Gains Tax. Understanding where Capital Gains Tax actually does, and does not, apply to inherited pension benefits can prevent unnecessary tax being paid at exactly the moment families can least afford a costly mistake.
Pensions Grow Free of Capital Gains Tax
Investments held within a pension, whether a workplace scheme or a Self-Invested Personal Pension, grow entirely free of Capital Gains Tax while they remain inside the pension wrapper. This remains true even after the pension holder dies. The investments themselves do not trigger a Capital Gains Tax charge simply because the pension holder has died and the pension passes to a beneficiary.
What Beneficiaries Actually Pay Tax On
Rather than Capital Gains Tax, withdrawals made by a beneficiary from an inherited pension are generally subject to Income Tax at the beneficiary’s marginal rate, particularly where the pension holder died aged 75 or over. Where the pension holder died before age 75, withdrawals can often be made entirely tax-free, subject to certain limits and provided the funds are drawn within the relevant time limits. In neither case does Capital Gains Tax apply to the pension withdrawal itself.
When Capital Gains Tax Does Become Relevant
Capital Gains Tax becomes relevant only once a beneficiary withdraws funds from the pension and then invests that money outside of a tax-advantaged wrapper, such as in a general investment account or in direct share ownership. From that point onward, any future growth on the reinvested funds is treated exactly like any other investment for Capital Gains Tax purposes, with the beneficiary’s own annual exempt amount and base cost applying from the date they acquired the new investment.
Pensions and the Estate for Inheritance Tax Purposes
Historically, most pensions sat outside the estate for Inheritance Tax purposes, which made them a popular estate planning tool. Rules in this area have been subject to significant government reform, so anyone relying on a pension as part of their Inheritance Tax planning should check the current treatment carefully, as the interaction between pensions, Inheritance Tax, and eventual Income Tax on withdrawals is one of the more actively evolving areas of UK tax policy.
Choosing Beneficiaries and Nomination Forms
Because pension death benefits are usually paid at the discretion of the scheme trustees rather than strictly under the terms of a will, keeping your expression of wishes or beneficiary nomination form up to date is essential. An outdated nomination can result in funds being directed in a way that no longer matches your actual wishes, regardless of what your will says.
Conclusion
Inherited pensions sit largely outside the world of Capital Gains Tax while the funds remain within the pension wrapper, with Income Tax being the more relevant consideration for beneficiaries making withdrawals. Capital Gains Tax only re-enters the picture once withdrawn funds are reinvested outside of a pension or ISA, at which point ordinary Capital Gains Tax rules apply to the beneficiary’s own new investment.
People Also Ask
Do beneficiaries pay Capital Gains Tax on an inherited pension?
No, withdrawals from an inherited pension are generally subject to Income Tax rather than Capital Gains Tax.
Does an inherited pension form part of the deceased’s estate?
This depends on the type of scheme and current rules, which have been subject to significant reform, so it should be checked on a case-by-case basis.
What happens if I reinvest money withdrawn from an inherited pension?
Once withdrawn and reinvested outside a pension or ISA, any future growth becomes subject to normal Capital Gains Tax rules based on your own base cost and annual exempt amount.
