For UK financial advisers only, not approved for use by retail customers. Click here for the customer website.

Pensions and Inheritance tax: planning ideas

15 min read 6 Apr 23

Please note this page was updated for tax year end prior to the Spring Budget on 15 March 2023 and the publication of the Finance (No. 2) Bill on 23 March 2023.

Based on the bill the Government intends to reduce LTA tax charges to 0% for the 2023/24 tax year, with a change in the taxation of death benefits. Additionally, there will be protection in place for those with LTA protections to maintain their higher entitlement to Pension Commencement Lump Sum.

Therefore, for the 2023/24 tax year there will still be a LTA in force and providers will still require all of the usual information for Benefit Crystallisation events even though the tax charge is intended to be 0%.

As this is currently a bill going through parliament it will not become law until it received Royal Assent, subsequently there may be amendments to this bill as it passes through parliament. We will update these pages once legislation is passed.

Furthermore, the government has stated that they intend to abolish the LTA in a future finance bill/act from the 2024/25 tax year. Once details on this are known we will make future updates to this page.

Pension planning  and making  contributions for others can be an effective way for the donor to reduce their taxable estate while saving into a pension for someone else. 

  • Pension contributions for others can be an effective way for the donor to reduce their taxable estate while saving into a pension for someone else.

  • It is good planning using up assets subject to inheritance tax before using pension assets.

  • Spousal bypass trusts were very popular before pension flexibility, to avoid inheritance tax on a quick second death. However, spousal bypass trusts are still useful in certain circumstances.

We’ll look at three planning strategies involving pensions and inheritance tax (IHT). And you can find details of pension-specific aspects of inheritance tax in our Inheritance Tax and Pensions Facts article.

Many inheritance tax (IHT) planning strategies involve making significant capital payments. The objective in doing so is to reduce the taxable estate. A trust is often used to retain control over the ultimate destination and timing of benefits.

One option is to use the tax advantages offered by contributions to registered pension schemes for 'others'.

People mistakenly believe that you will be limited to a contribution of up to £3,600 gross for your children or grandchildren. When the initial reply is followed up by the supplementary question; 'what if that child is in employment and earning £50,000 per year?' the size of the opportunity becomes apparent.

The benefits:

  • the estate of the donor reduces

  • basic rate relief at source from HMRC will effectively increase the gift by 25%

  • the recipient may benefit from a reduction in their tax bill if they are a higher or additional rate tax payer, perhaps they are affected by the child benefit or high earner tax traps

  • the fund enjoys tax advantaged growth – it suffers no income tax or capital gains tax charges

  • it can be used to relieve children and / or grandchildren of the need to fund for their pension at a time when resources may be stretched but benefits of pension contributions greatest

  • the recipient usually has no access to the gift until he / she attains normal minimum pension age which is currently 55

  • should the recipient die before age 75, tax-free death benefits (including lump sum) may be payable from the pension pot

The contribution will be treated as having been made by the scheme member for income tax purposes so will operate as described in Tax Relief on Member's Contributions article.

Devolved Taxation

Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole trades and partnerships), rental profits, and pension income (including the state pension). Similarly, from 6 April 2019 Welsh Taxpayers pay the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income.  

Other tax and deductions such as Corporation Tax, dividends, savings income and National Insurance Contributions etc. will remain based on UK rules. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same. For more info on SRIT and how this works in practice, please visit our facts page. For more info on CRIT and how this works in practice, please visit our facts page.

The IHT treatment will depend on whether the transfer of value (the contribution), is exempt or potentially exempt as described in the IHT articles.

One-off contributions (for non-Scottish taxpayer)

A one-off exempt gift can satisfy multiple planning needs and pass money down the generations tax-efficiently.

The same principles would apply to larger gifts using potentially exempt transfers but death within seven years could reduce or negate the IHT benefits.

Regular contributions (for non-Scottish taxpayer)

Regular contributions can be made using the £3,000 annual exemption available.

Larger regular gifts could be made out of surplus income using the 'normal expenditure out of income exemption'.

Income invested and remaining in estate

Surplus income per month


Value (if invested) after 10 years*


*5% return net of charges, paid monthly in advance


IHT payable on death
(where no Nil Rate Band available)


Pension contributions made for other

The 'Child's' Position

Basic Rate Tax Payer

Higher Rate Taxpayer

Additional Rate Taxpayer

Accumulated pension fund




Increase in income per annum through tax relief





  • IHT saved for 'the parent' would be £62,372 assuming 40% IHT rate,

  • accumulated value is greater due to the relief at source reclaimed by the pension provider,

  • those with exposure to tax at greater than basic rate tax will see a further 'gift' from HMRC.

This strategy can also be used if the child is caught in a tax trap, such at the High Income Child Benefit Charge, which can be read in this article.

Contributions to your own pension scheme are not usually lifetime transfers of value. However, If the contributions are made while the member is in good health there will be no transfer of value. But if made while the member is in ill health, there may be a transfer of value.

If we assume that there is no transfer of value then there can be a benefit to making pension contributions to your own pension for others to benefit from and save IHT. But the question as to whether or not this would make your beneficiaries richer depends on many variables;

  • What IHT would actually be saved (factoring in the tax relief that the member gets)?

  • Would there be any matching from an employer?

  • Will the member qualify for tax relief?

  • When is the member likely to die (which can affect the tax position of the death benefits)?

  • What tax rates would apply to any beneficiaries?

  • Will there be an annual allowance excess?

  • Will there be a lifetime allowance excess?

  • How will death benefits be paid based on the scheme rules?

To illustrate the point, let’s assume that we are looking at a higher rate taxpayer (40%), who has used up all of their lifetime allowance and has an IHT issue. They have £10,000 that they are looking to use for IHT planning purposes.

If that £10,000 stays in the estate, after IHT the beneficiaries will get £6,000.

If that £10,000 was paid into a relief at source defined contribution scheme, this will be grossed up to £12,500. However, once a tax return has been completed the amount of the contribution means that they get back £2,500 in their tax return as they had paid sufficient higher rate tax to justify this.

So to get £12,500 in a pension has cost them £7,500. This saves £3,000 in IHT.

Take the LTA excess as a lump sum (for death prior to 75)

If they then die, as there is no LTA left this will be a LTA excess. If taken as a lump sum by a beneficiary, this would be subject to 55% LTA excess lump sum excess and the beneficiary would get £5,625 (£12,500 less 55%). So taking this as a lump sum (perhaps the scheme rules only allow a lump sum) would make your beneficiary poorer on the face of this.

But we have to remember that there is still £2,500 that came back in the tax return based on the original £10,000 pension contribution. The net cost was £7,500, so there is £2,500 still in the estate. After IHT that would provide an additional £1,500. So the net benefit to the beneficiary is £7,125. So by definition in this example the beneficiary is £1,125 richer assuming no growth.

Take the LTA excess as an income

This is where more variables come into play, as we also have to factor in the income tax position of the beneficiaries as well as when the member dies. 

If the member dies before 75

Keeping the above example, if the benefits from the pension are taken as a lump sum the 55% tax charge would apply, and as we have seen the net benefit (including the £2,500 left in the estate) would be £7,125.

But if the beneficiaries can take this as an income and if this is paid within the 2 year window of the scheme becoming aware of the members death , then a 25% LTA charge would apply.  See Death benefits from defined contribution schemes for more information on this.

After the LTA excess charge of 25% is deducted from the pension then there is £9,375 left in the pension, which is tax free as the member died under 75 and the death benefits were settled with 2 years. Add on the £1,500 received from the estate after IHT has been paid as before and that £10,000 that was subject to IHT has become £10,875.

If the member dies after 75

When the member reaches age 75 the LTA excess would be subject to a LTA test and 25% would be deducted. So as per the above there would then be £9,375 left in the pension and as this is a defined contribution scheme there will be no further LTA test that can apply.

But the benefits will be taxable at marginal rates for a beneficiary (assuming the beneficiary is a person and not a trust for example). Now we have to factor in what that would be, and we are assuming that the death benefit is taken wholly within that tax band.

If the beneficiary is a basic rate taxpayer, then they would net £7,500 from the pension and £1,500 from the estate. A net £9,000 from the original £10,000 that was being used for planning. So overall a 10% reduction from what the member originally had, not too bad.

A higher rate beneficiary would still get £7,125 all in, and an additional rate taxpayer would get £6,656.

If we compare what they would have gotten if that £10,000 has been left in the estate a basic or  higher rate beneficiary would be better off with the member putting this in the pension than simply receiving £6,656 from the estate. An additional rate beneficiary would be better off by £656.

In summary about using your own pension for IHT planning.

All of the above have of course been run on various assumptions and for each case this would be client specific, but while the results may vary, the calculations don’t. After speaking to your client, checking what they want to happen, what the beneficiaries tax rate would be, what the scheme offers and of course that the contributions themselves are going to be exempt from IHT. then the numbers won’t lie as to what would make the beneficiaries richer.

Registered pension schemes do not enjoy a general exemption from IHT. However, there are specific provisions which grant relief in many situations.

The treatment of pensions for IHT purposes is covered in our article Inheritance tax and pensions.

Given the beneficial IHT treatment of pensions a logical approach to IHT planning could be to finance all living expenses from non-pension assets, at least until age 75. These assets are 'in the estate' so using them up would potentially lessen any future IHT bill. 

Inheritance Tax 1984 section 3 (3), which was designed to prevent the diminishing of an estate by deliberately failing to exercise an option, was a significant drawback for this strategy. However, this legislation was removed for pensions in Finance Act 2011. This means it is possible to:

  • draw on non-pension income and capital to fund living costs until age 75 and leave pension funds untouched safe in the knowledge that with effect from 6 April 2011 section 3 (3) will not apply. Taxable assets will be diminished. The pension funds will not form part of the client's IHT estate,

  • where appropriate 'conventional' IHT strategies could be used for the taxable estate,  

  • post-75 conventional IHT planning can be used. Consideration could be given to using flexi-access drawdown (or capped drawdown if this type of scheme was set up before April 2015) to create surplus income from which exempt gifts could be made. Strategies aiming to avail of the 'normal expenditure from income' exemption could be beneficial,

  • any pension commencement lump sum ('tax-free cash') can be invested to meet the client's post-75 needs and avoid the post-75 marginal income tax rate of the recipient that would apply on death.

The repeal of section 3(3) in relation to pension funds has widened the spectrum of potential planning strategies.

Under the previous regime it was not uncommon to use a discretionary trust as the recipient of death benefits to ensure the money remained outside the estate of the intended beneficiary. These are commonly called spousal bypass trusts (SBTs) as they enable the funds to bypass the estate of a spouse (or anyone else) and so be available for future generations. The spouse can then draw from the trust, by way of the trustees extending a loan to the beneficiary that is to be repaid on death. In this way, the trust can be used as a “drawdown fund” but on death the funds are returned to the trust to be passed on to the next in line. Detailed information on SBTs can be found in the Spousal Bypass Trusts article.

Money within the trust is subject to all normal IHT rules and therefore subject to periodic and exit charges, where the value is above the available nil-rate band.

The cost of control

However, with the introduction of new forms of beneficiary drawdown it is possible for a fund to continue in the pension wrapper indefinitely and can continue to grow free of income tax, capital gains tax and inheritance tax.

Crucially, leaving the funds within the pension avoids tax potential for a tax charge on the lump sum payment which would be made to the SBT.

A lump sum paid to a SBT on death of the member before age 75 usually passes tax-free, although subsequent investment growth would not enjoy the same tax privileged experience within a pension.

Where a lump sum payment is made to a bypass trust in respect of a member who died aged 75 or over, a tax charge of 45% continues to apply. This will continue to be the case for the majority of any payments in future as the trust only benefits from £1,000 at basic rate and thereafter everything is taxed at 45%.

For example, a fund of £200,000 would pay a special lump sum death benefit charge of £90,000 if it were being paid to a SBT, where the deceased member was aged 75 or above.

On the face of it this seems an improvement over the pre-April 2015 position where there would be a 55% tax charge on the lump sum.

However, the 45% tax charge levied on payment to the trust may not be totally lost. If the trustees subsequently pay the funds within the trust  to an individual, the 45% is off-settable and the individual beneficiary may claim relief for the 45% tax on the portion of the money distributed .

Subsection (7) and (8) S206 of the Finance Act 2004 Subsection (7)

So (in the context of a bypass trust) a payment of Lump Sum Death Benefit to the trust then to a beneficiary is treated as income of that beneficiary, net of a reclaimable 45% tax credit.

However, notwithstanding the above, under the Freedom & Choice reforms the fund could pass to a beneficiary's flexi-access drawdown (dependant or nominee flexi-access drawdown) with no initial deduction of tax. It could then be passed to successive generations (via successors flexi-access drawdown) while never being subject to periodic or exit charges. Withdrawals from the dependant / nominee flexi-access drawdown will be tax-free if the original member died before age 75, and liable to income tax at the marginal rate of the recipient if the member died at age 75 or over. The taxation of withdrawals from any subsequent successors flexi-access drawdown account will be dependent on the age the previous dependant / nominee / successor died.

Once a fund has passed to a beneficiary it is then the beneficiary’s choice (or the scheme's) who will benefit in future. This may mean the fund being 'out of the family' or otherwise going to individuals the original member may not have approved of. The SBT continues to offer a way of controlling who will benefit in future by controlling who is an allowable beneficiary. The potential tax charges reduce the amount received (and the potential for growth as a result of the reduced fund available for investment) but at least there is more confidence in who will receive it.

Merely having the fund paid to a SBT will not guarantee descendants receive a fund: the first beneficiary could exhaust the fund and have insufficient assets to repay the loan causing it to be written off, and the inheritance with it. One option is to limit the powers of the trustees so that they may only advance the growth to the first beneficiary with the capital being retained for the next in line (interest in possession). Where this is not practical, it may be advisable to look at projections based on the amount the trust will receive – does it seem realistic the next in line will receive a suitable amount given the initial tax charge? A guarantee of receiving the ‘fund’ is not a guarantee of receiving ‘funds’.

Consider Where...

Hazards Where...

  • The member has a complex family situation and clear wishes around who should, and shouldn’t, benefit.
  • The member is aged 74 or below, as the lump sum death benefit would be paid tax free.
  • An interest in possession option would meet the client's needs.
  • The member is aged 75 or over at death. This will be subject to a 45% tax charge (however, subsequent payment to a beneficiary is treated as income of that beneficiary, net of a reclaimable 45% tax credit).
  • If it is a large fund potentially subject to periodic and exit charges within the trust.

  • Example


    Mrs White (75) has recently transferred out of her defined benefit scheme into a personal pension, primarily to provide better death benefits should she die. Mrs White is however concerned that should her husband remarry after her death the funds may then be passed to the new spouse or her family.


    Mrs White’s financial adviser explains that under the new death benefit rules, it will be up to her beneficiary where the fund goes after the beneficiary's death. For example, Mr White could choose to leave any remaining fund to his new partner or her family on his death.

    While this may be the most tax-efficient option, the lack of control over the future of the fund concerns Mrs White. An alternative is to update her expression of wish to direct the funds to a spousal bypass trust. On her death the funds would be paid as a lump sum and so subject to 45% tax. The remaining 55% would then be available for her partner to draw on as required, subject to the trustees approval. Payments from the trust to her partner are treated as income of that beneficiary, net of a reclaimable 45% tax credit.

    On Mr White’s death the trustees may choose to repay the loan of capital to the trust (perhaps to save on IHT) but even if they choose not to do this, any capital remaining in the trust will be distributed according to the trust deed. Mrs White may have directed this to return to her family and so maintains control over the remaining assets.

    Of course, this strategy requires the trustee to maintain control over the assets to ensure Mr White does not simply extract all the money during his life. It may be more appropriate to write the trust as an interest in possession (IIP) to help ensure the original capital can be passed on, as a minimum.

    It should be noted however that the income may be substantially less than a form of beneficiary drawdown may produce as a result of the 45% tax charge. Where an IIP trust is not used this may mean more strain is placed on the fund with the result that while control is maintained there is, practically, no fund left to control for the third generation.

    Related insights