Passing a Pension to Children Tax-Efficiently

For years, a pension has been one of the most tax-efficient assets a parent or grandparent could leave to the next generation — particularly if death occurred before age 75, when benefits could often be paid to children largely free of income tax, and the pension itself usually sat outside the estate for inheritance tax altogether. The incoming 2027 changes alter part of that picture significantly, but pensions are likely to remain a meaningful, if less dramatically favourable, way to pass on wealth. This page sets out why pensions have been so effective for this purpose, what changes, and what remains worth knowing if you want to pass a pension to your children as efficiently as the rules allow.

Why pensions became such an efficient way to pass on wealth

Two features combined to make pensions unusually attractive for passing wealth to children. First, the income tax treatment of death benefits has long depended on the age at which the pension holder died: if death occurred before age 75, lump sums and drawdown income paid to beneficiaries could often be received largely free of income tax, subject to certain allowances and time limits. Second, and separately, an unused defined contribution pension pot has not normally counted as part of the deceased's estate for inheritance tax purposes, meaning it escaped the 40% charge that applies to most other assets above the nil-rate band.

Put those two features together and you get a genuinely powerful combination: a pot of money that, in the right circumstances, could pass to a child with neither income tax nor inheritance tax deducted from it — a rare position for any significant asset to be in. This is why financial advisers have long recommended, where circumstances allow, spending other assets first in retirement and preserving pension wealth for as long as possible, specifically because of how efficiently it could ultimately reach the next generation.

How the 2027 changes affect this strategy

From April 2027, most unused pension funds will generally form part of a person's estate for inheritance tax purposes. This removes the second of the two advantages described above for most estates large enough to be affected by inheritance tax — the pension will typically no longer escape the 40% charge simply by virtue of being a pension. The income tax treatment based on age at death (broadly, more favourable before 75, less favourable from 75 onwards) is expected to continue operating alongside the new inheritance tax treatment, meaning a pension inherited from someone who died after 75, within a taxable estate, could face both taxes rather than either one alone.

This reduces, but does not eliminate, the relative tax efficiency of pensions compared with other assets. A pension left by someone who died before 75, within an estate that stays below the available nil-rate bands even with the pension included, could still reach a child with no income tax and no inheritance tax — exactly as before. It is really the combination of a larger estate and death after 75 that produces the most significant change in outcome, since that is where both the new inheritance tax charge and the existing income tax charge can apply to the same money.

Leaving a pension to a child: before vs after 2027

Practical considerations that remain relevant post-2027

Even with the 2027 changes, several practical steps remain just as important — arguably more important — for anyone hoping to pass a pension to their children as tax-efficiently as possible. Correctly nominating beneficiaries through an up-to-date expression of wishes remains essential, since this still guides who receives the pension and, in many schemes, how flexibly they can access it. Considering a nominee's drawdown or successor's drawdown arrangement is also worth understanding: rather than taking an inherited pension as a single lump sum, many schemes allow a child to become a "nominee" or "successor," inheriting the pension pot itself and drawing it down flexibly over time, much as the original pension holder could have done. This can help manage the income tax due on withdrawals by spreading them across multiple tax years rather than triggering a large tax bill by withdrawing everything at once, and it also allows the money to continue growing within a tax-advantaged pension wrapper for longer.

A successor's drawdown arrangement can, in some cases, even be passed down again to a further generation on the death of the successor, continuing the pattern of flexible, staged access rather than a single lump sum extraction. Whether this makes sense for a particular family depends heavily on individual circumstances — the ages and tax positions of the beneficiaries, the size of the pot, and the wider estate — and is exactly the kind of decision worth discussing with a financial adviser rather than assuming one approach is automatically best.

A worked example

Consider Angela, who dies at 68 (before 75) leaving a £220,000 pension pot to her daughter, within an estate that totals £480,000 including the pension, house, and savings combined. Under the post-2027 rules, because her total estate including the pension is below her combined nil-rate band and residence nil-rate band of up to £500,000, no inheritance tax is due at all, and because Angela died before 75, her daughter can typically draw down the inherited pension free of income tax as well — a genuinely efficient outcome even under the new rules. Now compare Angela's brother, who dies at 79 leaving an identical £220,000 pension pot to his son, but within a larger £700,000 estate. Because his estate exceeds the available nil-rate bands even before adding the pension, the pension's inclusion adds directly to his taxable estate, and because he died after 75, his son also pays income tax at his marginal rate on withdrawals — the least efficient combination of the two brothers' situations, despite passing on an identical pension amount.

This comparison shows that the same £220,000 pension can produce very different outcomes for the next generation depending on two factors entirely outside anyone's control at the time of planning: the age at which the pension holder dies, and the overall size of their estate at that point. It is precisely this unpredictability that makes broad, flexible estate planning — rather than a single rigid strategy built around one assumed scenario — the more sensible approach for most families.

It is worth stressing again that these examples are simplified for clarity. Real families often have more complex circumstances — multiple children with different needs, blended families from second marriages, business assets, or property in more than one country — all of which can significantly change how a pension should best be structured and nominated. The general principles described here provide a useful starting point for understanding the shape of the rules, but they are not a substitute for advice tailored to your own specific situation.

Passing a pension to grandchildren

Many of the same principles apply if you want to pass a pension to grandchildren rather than, or in addition to, your own children, though a few extra considerations come into play. Most pension schemes allow a nomination to name grandchildren directly, either instead of or alongside children, and some schemes also allow "transmission" of a successor's drawdown arrangement across more than one generation, meaning a grandchild could ultimately inherit pension wealth that has passed through a nominee or successor drawdown chain from the original holder, through a child, without ever being fully withdrawn as a lump sum along the way. This can be a particularly efficient way to keep money within a tax-advantaged pension wrapper across multiple generations, though the precise rules depend heavily on the specific scheme, and not every provider offers the same flexibility.

One consideration worth being aware of is that naming a grandchild directly, rather than routing money through a child first, can sometimes simplify the eventual tax position for the child's own generation, since money that passes directly to a grandchild does not sit in the child's own estate at any point. Whether this is desirable, and whether it fits with the family's broader wishes about who benefits and when, is a genuinely personal decision that benefits from professional advice rather than a one-size-fits-all rule.

Common misconceptions about passing on a pension

A few misunderstandings recur often enough to be worth addressing directly. Some people assume that because pensions are becoming less inheritance-tax-efficient from 2027, it no longer makes sense to save into a pension at all, or that money would be better held as cash or other investments instead. This is generally not the case: the tax relief on pension contributions, the tax-efficient growth within the pension wrapper during your lifetime, and the flexibility of drawdown all remain valuable regardless of the eventual inheritance tax treatment of any unused balance, and cash or other investments held outside a pension are not automatically more tax-efficient overall, particularly once income tax on pension withdrawals and the various allowances are properly compared.

Another misconception is that the 2027 changes make pensions uniquely disadvantaged compared with other assets. In reality, the reform brings pensions closer to parity with how most other significant assets — property, savings, investments — have always been treated for inheritance tax, rather than singling pensions out for unusually harsh treatment. Pensions remain, in many cases, one of several broadly comparable options for passing on wealth, rather than either the standout best option they once were or a newly disadvantaged one.

Coordinating pension planning with wider estate planning

Because pensions can no longer be relied upon to sit entirely outside the estate, coordinating pension planning with the rest of your estate plan — your will, any trusts, and any lifetime gifting strategy — matters more than ever. A will that hasn't been reviewed alongside your pension nominations, or a gifting strategy that doesn't account for the pension now potentially adding to your taxable estate, can produce outcomes quite different from what you actually intend. Trusts, in particular, can play a role in some estate plans for managing how and when descendants receive an inheritance, though setting one up correctly requires professional legal and tax advice tailored to your specific family circumstances, rather than a generic template.

Lifetime gifting also remains a relevant tool for some families — giving away assets (potentially including money drawn from a pension) during your lifetime can, subject to the normal seven-year survival rule and other gifting allowances, reduce the eventual size of your taxable estate. However, gifting decisions should never be made purely to reduce a future tax bill without also considering your own retirement income needs; running down your own resources too aggressively to benefit children tax-efficiently can leave you short later in retirement, which is rarely the right trade-off.

Life insurance written in trust is another tool some families use specifically to address a future inheritance tax bill, including one that arises because a pension is now counted within the estate. Rather than trying to avoid the tax altogether, this approach accepts that some inheritance tax may be due and simply ensures that funds are available to pay it without forcing the family to sell a house or access an illiquid asset in a hurry. Whether this makes sense depends on cost, health, and the likely scale of any eventual liability, and is again a decision best made with professional advice rather than in isolation.

Finally, it's worth revisiting your plans periodically rather than treating this as a one-off exercise completed once and forgotten. Pension values change, property prices move, family circumstances evolve, and the detailed rules around the 2027 reform are still being finalised through consultation. A plan that makes sense today may need adjusting in a year or two as the picture becomes clearer, so treating estate and pension planning as an ongoing conversation, rather than a single decision, tends to serve families better over the long run.