Transferring a private pension and reallocating the balance after taking the 25 per cent tax-free lump sum requires careful planning. The remaining pension fund can be reinvested via pension drawdown, where it stays invested and can be withdrawn as needed subject to income tax, or you can leave the funds to grow without drawing income.

The rules surrounding pension inheritance depend largely on your age at the time of death. Typically, when setting up your pension, you complete a nomination of beneficiary form. This form allows you to name an individual, individuals, or a trust as beneficiaries who will inherit your pension when you die. While scheme administrators hold discretion over who receives the funds to keep pensions free from inheritance tax (IHT), they almost always follow the instructions provided in the nomination form unless there is a significant change in circumstances. If you are uncertain about your nominated beneficiaries, your scheme administrator can provide the necessary details.

If you pass away before the age of 75, your pension is typically passed on to your beneficiaries entirely tax-free, regardless of whether you have previously accessed the pension and drawn the 25 per cent lump sum and/or income. Any cash lump sums for deaths before age 75 are subject to your available lump sum and death benefit allowance. Anything above this will be taxed at the beneficiary’s marginal tax rate.

Your beneficiaries can choose to receive the pension in two ways. One option is to take the entire remaining pension fund as a tax-free lump sum. Alternatively, they can keep the money in a pension, either through beneficiary drawdown or by purchasing an annuity. Any withdrawals they make will also be free of income tax. To maintain this tax-free status, the pension funds must be transferred into the beneficiary’s name within two years of your death.

If you pass away after reaching the age of 75, your pension will still pass to your beneficiaries, but the tax treatment changes. If your beneficiaries inherit the pension through drawdown, any withdrawals they make will be subject to income tax at their marginal rate at that time. They can also choose to take the remaining pension as a lump sum, but this will also be subject to income tax based on their total taxable income for that year.

If you have nominated a trust to inherit the pension, the tax situation is different. Bypass trusts are a form of discretionary trust, and any funds paid to them are typically taxed at 45 per cent. If the ultimate beneficiaries are taxed at a lower rate than 45 per cent when receiving a trust distribution, they can reclaim the difference through a self-assessment tax return.

Pensions are typically exempt from IHT, but in some cases, a pension can become subject to IHT. If you transfer your pension while in poor health and die within two years, HMRC may treat this as a transfer of value, particularly if the death benefits are paid at the discretion of the receiving scheme’s trustees. In such a case, IHT could apply, and the spouse exemption may not be available.

While pensions are free from IHT, any assets taken out of them, such as the 25 per cent tax-free lump sum, will be included in your estate. For example, if you withdraw £250,000 tax-free from a £1mn pension to pay off a mortgage or top up savings, and then die before using the money, that £250,000 is added to the value of your estate and could push it over the IHT threshold, making the excess subject to the 40 per cent IHT rate. If you gift the withdrawn funds, you need to survive seven years for them to be excluded from your estate for IHT purposes.