Eight vital things to know about passing on income drawdown

A core reason why people choose to keep their pensions invested in retirement and avoid guaranteed income products such as annuities, is the facility to leave the unspent pot to loved ones.

One of the potential options here is called beneficiary (or nominated) drawdown, which enables leftover funds to remain inside a pension wrapper, retaining some key tax perks and affording flexibility over withdrawals.

• Invest with ii: Open a Low Cost SIPP | What is a SIPP | Interactive investor Offers

This means that, in theory, pension pots can cascade down generations, an approach that can hold appeal for some investors and families. However, we should note that with each baton change the inherited pot is likely to shrink significantly, especially once inheritance tax (IHT) enters the equation in April 2027.

But like other areas of the pension tax framework, the rules around beneficiary drawdown can be complicated, and importantly aren’t applied in the same way as standard drawdown.

Let’s run through some of the crucial things you need to know when seeking to pass on a drawdown account.

1) The plan must be in drawdown on death

First things first, beneficiary drawdown is only available to funds held in a flexi-access drawdown account at the time of death.

Flexi-access drawdown refers to the pension savings that you’ve kept invested in retirement but have ‘crystallised’. In other words, you’ve drawn 25% tax-free cash and moved the rest into a pot where you can take flexible income whenever you like.

So, if some of your pension savings are in drawdown but other pots are uncrystallised - it’s only the drawdown portion that can provide beneficiary drawdown.

On any unvested pensions, the money will be paid to your chosen beneficiaries as either a single lump sum or a survivor’s annuity.

2) Beneficiaries might pay income tax on withdrawals, but they might not

Whether beneficiary drawdown income is taxable depends on the age of the original plan holder when they pass away. If it occurs before their 75th birthday, withdrawals are tax free, provided the benefits are paid, or designated into another arrangement such as drawdown, within two years of the following: the date the pension provider was notified of the death or the date they could reasonably have been expected to know of the death.

• 8 ways to cut your IHT bill in 2026
• Top 10 funds for SIPP accumulation and drawdown pension savers

In contrast, if death occurs after age 75, withdrawals are added to the beneficiary’s other income during the tax year in question and taxed at their marginal rate.

Importantly, the tax rules reset on death. Here’s an example:

Maureen dies at age 76 and leaves her flexi-access drawdown account to her husband, Jim, who’s 72. As Maureen was aged 75 or older on death, any withdrawals Jim makes will be taxable.

Jim dies two years later at the age of 74 and leaves the drawdown plan to his son, Terry. As Jim was under age 75, Terry won’t pay income tax on withdrawals.

3) Your current SIPP provider must offer beneficiary drawdown

Unless your SIPP provider offers the option of beneficiary drawdown, your heirs can’t inherit such an account. For instance, they can’t receive the death benefits and open a beneficiary drawdown account with a different provider.

This is important, because if the only death benefit option your provider permits is a lump sum and you die after age 75, the full amount will be added to the recipient’s income for the year in question and taxed at their marginal rate. If the value on death is significant, the tax bill could be, too.

In contrast, if they inherit flexi-access drawdown, they can leave the money inside the pension wrapper and stagger withdrawals, offering more scope to keep within the lower tax brackets.

So, let’s say a parent passed away after age 75 and left you a pension drawdown account but you’re still working and earning a good wage. It might make sense to delay accessing the pot until you retire when withdrawals won’t be taxed as heavily.

Once a drawdown account has been inherited, the recipient is free to transfer to a different provider (who offers beneficiary drawdown) at any point.

Beneficiary drawdown can also be passed to a loved one on death – this is called successor drawdown.

4) The money continues to grow tax free, but tax-free cash isn’t preserved

One of the main upshots of passing a pension wrapper to a loved one on death is that some valuable tax advantages are retained. Any future growth is free from capital gains tax (CGT) and dividends are tax free too.

If the pension is paid out as a lump sum, it’s possible to direct that money towards tax wrappers such as pensions and individual savings accounts (ISA), but this might take some time due to the annual contribution limits in place.

• Is an ISA the missing part in your retirement plans?
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

While investments inside a beneficiary drawdown account can continue to grow tax free, any unused tax-free cash, otherwise known as the pension commencement lump sum, is lost on the death of the previous owner. It can’t be inherited. This is something to be mindful of if you plan to designate drawdown to a loved one on death and are over age 75.

5) Beneficiaries can access the money before minimum pension age

With most pensions, the money is locked away until you reach normal minimum pension age (NMPA) of 55 (rising to 57 in 2028). There are a couple of instances where you can access the pot sooner, such as if it has a protected pension age or you’re in serious ill-health.

However, the NMPA restriction doesn’t apply to beneficiary drawdown. Whoever inherits the account is legally allowed to make withdrawals whenever they like.

6) Future withdrawals won’t trigger the MPAA

One banana skin of making a flexible and taxable withdrawal from your pension savings is that it triggers the money purchase annual allowance (MPAA), which shrinks the amount you can pay into pensions every year and gain upfront tax relief from £60,000 to £10,000. What’s more, you lose access to carry forward relief, meaning you can no longer tap into unused pension allowances from the previous three tax years.

But importantly, the MPAA doesn’t apply to beneficiary or successor drawdown, so you can make taxable withdrawals (again, which occur if the plan owner died after age 75) without restricting future annual pension contributions.

7) Inheritance tax might apply after April 2027

In around 11 months’ time, most pension pots will fall inside the estate calculation for IHT purposes on death. Until then, a drawdown account can be inherited IHT free, and you’ll only pay income tax on withdrawals if, as noted above, the previous owner was aged 75 or older on death.

• Pensions and IHT: the countdown to new tax rules has started
• Tony Blair Institute’s radical proposal to overhaul state pension

But that doesn’t necessarily mean whoever inherits a drawdown account will pay IHT. First, if the previous owner was a spouse or civil partner, no IHT is payable. Second, it’s only the amount above the deceased’s tax-free threshold (which for married couples could be up to £1 million) that’s liable to IHT.

Something to note, however, is that from April 2027, the recipient of pension benefits on death, including flexi-access drawdown, could suffer both IHT on the inherited account and income tax on withdrawals. This could create a combined tax rate of somewhere between 52% and 67%, depending on the beneficiary’s marginal tax rate during the year the income was taken.

8) Think carefully about who you want to benefit and tell your provider

In most cases, people will want their drawdown account to pass to a surviving spouse first, then to any children afterwards.

But you don’t have to follow this course. You can designate pension drawdown to whoever you like, even several people if that’s your preference, and the inherited shares don’t have to be split equally.

If you wish to leave a drawdown plan to someone other than your surviving spouse, be mindful of IHT which may apply if death occurs after April 2027.

Once you’ve chosen your beneficiaries, make sure you complete an expression of wishes form, which lets your provider know who you want the money to go to. While your provider’s trustees still ultimately have discretion over where the pension pot ends up on death, they typically carry out your wishes.

Take advice if you’re unsure...

The pitfalls of making the wrong choice when passing a drawdown plan to loved ones on death can be severe, particularly with the big IHT change just around the corner. Your retirement pot could end up in the wrong hands, or the recipient could be hit with a monster tax bill. Given the complexities involved, it’s wise to seek expert advice from a regulated financial planner.