Is a SIPP Subject to Inheritance Tax?

A Self-Invested Personal Pension (SIPP) is a specific type of UK government-registered personal pension scheme. It provides individuals with the ability to choose and manage their own investments from a broad range approved by HM Revenue and Customs (HMRC), offering more control than traditional personal pensions. SIPPs function as “tax wrappers,” allowing tax relief on contributions in exchange for limits on accessibility.

Inheritance Tax (IHT) is a tax levied in the UK on the estate of someone who has died. The standard IHT rate is 40% on the portion of the estate that exceeds the tax-free threshold, known as the nil-rate band. This article explores when a SIPP may be subject to UK Inheritance Tax.

General Principle: Pensions and Inheritance Tax

Pension funds, including SIPPs, typically fall outside an individual’s taxable estate for Inheritance Tax purposes under current UK rules. This general exemption exists because pension funds are generally held in trust by the pension provider and are paid out at the discretion of the scheme administrator, rather than forming part of the deceased’s legal estate. This discretionary payment mechanism means the pension holder does not legally own the funds in a way that would automatically subject them to IHT upon death. This principle applies broadly to most registered pension schemes, making them a tax-efficient vehicle for passing on wealth to beneficiaries.

A key element in maintaining this IHT-exempt status is the use of a “nomination of beneficiaries” form, often referred to as an “expression of wish” form. This document allows the pension holder to inform the scheme administrator whom they would like to receive their pension funds upon death. While the scheme administrator is not legally bound by this nomination, they typically follow it, ensuring the funds are distributed outside the deceased’s estate. This discretionary payment prevents the funds from being considered part of the deceased’s estate for IHT purposes; if the pension holder could legally direct the payment, the funds would likely be included in their estate.

Circumstances Where a SIPP May Be Subject to Inheritance Tax

Despite the general IHT exemption for pensions, specific situations can cause SIPP funds to become subject to Inheritance Tax. One such scenario arises from the absence of a valid beneficiary nomination. If no up-to-date nomination exists, or if the pension scheme’s rules mandate payment directly into the deceased’s legal estate, SIPP funds would then be included in the estate and potentially taxed.

Funds withdrawn from a SIPP and held personally before death lose their IHT-exempt status. If an individual takes a lump sum from their pension and these funds remain in their personal bank account or other assets at the time of death, they become part of the taxable estate. Accessing tax-free cash, even if not immediately spent, can expose those funds to IHT if they remain within the estate.

Pension recycling is another area where IHT could apply. This occurs when an individual withdraws funds from a pension, particularly tax-free cash, and then re-contributes them to another pension scheme with the primary aim of generating further tax relief or avoiding IHT on other assets. HMRC scrutinizes such arrangements; if the recycling is deemed pre-planned and meets specific criteria, it can lead to penalties including an unauthorised payment charge. HMRC views this as an attempt to exploit tax rules, potentially bringing the recycled amount back into the taxable estate.

Transferring a pension between schemes while in severe ill-health, particularly shortly before death, may also attract IHT scrutiny. HMRC might consider such a transfer as a “transfer of value” if it appears to be primarily for the purpose of avoiding IHT by securing more favorable death benefits. This is particularly relevant if transferring from a scheme with less flexible death benefits to a SIPP, where the fund value can be passed on. HMRC assesses the loss to the estate caused by such a transfer, and if the individual dies within two years, IHT could be levied on that value.

Significant changes are planned for the IHT treatment of pensions. From April 6, 2027, most unused pension funds and death benefits will be included in a person’s estate for Inheritance Tax purposes. This means the IHT exemption will largely cease, potentially subjecting these assets to the 40% IHT rate. While specific details are still being finalized, personal representatives will be responsible for reporting and paying any IHT due on unused pension funds.

Ensuring Your SIPP Remains Outside Your Estate

To ensure a SIPP remains outside the taxable estate for Inheritance Tax purposes, it is essential to complete and regularly review the “nomination of beneficiaries” or “expression of wish” forms with the SIPP provider. These forms guide the scheme administrator’s discretion regarding who should receive the pension funds upon death, which is fundamental to maintaining the IHT-exempt status. Without a valid nomination, the pension funds may default to the estate.

Life events such as marriage, divorce, the birth of children, or the death of a nominated beneficiary necessitate a review and update of these forms. Keeping nominations current ensures the pension provider has accurate information and can follow the individual’s wishes, which helps prevent funds from inadvertently falling into the taxable estate.

Avoid withdrawing large lump sums from a SIPP unless the funds are immediately required for living expenses or other specific needs. Once funds are withdrawn from the pension wrapper, they lose their IHT-exempt status and become part of the individual’s personal assets, potentially subject to IHT upon death. Keeping funds within the SIPP structure preserves their IHT-advantaged treatment for beneficiaries.

Understanding the rules surrounding pension recycling is important. Individuals should be cautious about withdrawing tax-free cash and then re-contributing it to a pension, as HMRC may view this as an attempt to exploit tax relief and impose penalties. While the intent is to prevent abuse, the rules can be complex, and professional advice should be sought if considering such strategies to avoid unintended tax consequences.