Inherited ISA vs Inherited Pension: Tax Treatment Compared (2026/27)

Why ISAs and Pensions Are Treated So Differently on Death

Both ISAs and pensions are marketed as "tax-free" savings vehicles while you're alive. But the moment you die, the two products diverge sharply — and the difference comes down to who inherits, not just what they inherit.

An ISA's tax-free status is a personal entitlement tied to the account holder. When that person dies, the wrapper doesn't automatically transfer with the money — HMRC only allows one specific workaround, the Additional Permitted Subscription (APS), and it's reserved for a surviving spouse or civil partner.

A pension, by contrast, is designed from the outset to pass to a nominated beneficiary — spouse, child, grandchild, or anyone else named on the expression of wishes form — and its tax treatment on death depends mainly on the age of the person who died, not on the relationship to the beneficiary.

Inherited ISAs: The Additional Permitted Subscription Explained

If you're a surviving spouse or civil partner, you can apply for an APS — an extra one-off ISA allowance equal to the value of your late partner's ISA. This sits on top of your own £20,000/year ISA allowance, so a £100,000 inherited ISA doesn't need to be spread over five tax years; the whole amount can be sheltered via the APS in one go (subject to your provider's process).

If you are not a spouse or civil partner — for example, an adult child inheriting a parent's ISA — there is no APS available to you. You simply inherit the underlying cash or investments as part of the estate. That money:

• Forms part of the deceased's estate and is assessed for inheritance tax alongside everything else they owned
• Loses its ISA tax-free wrapper the moment it's paid out to you
• Can only regain a tax-free wrapper if you personally pay it into your own ISA, limited to your standard £20,000/year subscription allowance

Inherited Pensions: Tax-Free Before 75, Taxed After

Pensions work on a different trigger entirely: the age of the pension holder at death, not the relationship of the beneficiary.

• Died before age 75: most defined contribution pension pots can be passed to any nominated beneficiary completely free of income tax, whether paid as a lump sum or drawn down over time.
• Died at or after age 75: the beneficiary pays income tax on withdrawals at their own marginal rate — 20% basic rate, 40% higher rate, or 45% additional rate — depending on their total income in the tax year they withdraw.

Crucially, this rule applies regardless of whether the beneficiary is a spouse, child, or anyone else. A grandchild can inherit a pension completely tax-free (if death was before 75) in exactly the same way a spouse can — something an ISA can never offer to a non-spouse.

Worked Example: £100,000 ISA vs £100,000 Pension, Left to an Adult Child

Suppose a parent dies leaving an adult child £100,000 in an ISA and £100,000 in a pension. The child is not a spouse, so no APS applies.

The ISA £100,000:

• It forms part of the parent's estate for inheritance tax purposes. If the overall estate exceeds the available nil-rate band (£325,000 for most estates, potentially more if a residence nil-rate band or spousal transfer applies), the amount above that threshold is generally taxed at 40%.
• Once the estate is settled and the child receives the cash, it has no ISA wrapper. Held in a savings account or investment account, any future interest, dividends, or capital gains are potentially taxable.
• To fully shelter the £100,000 in an ISA going forward, the child needs at least five tax years at the current £20,000/year allowance — assuming they use their entire allowance on nothing else.

The pension £100,000:

• If the parent died before age 75, the child can receive the full £100,000 with no income tax due at all — the pension passes on outside income tax entirely.
• If the parent died at or after age 75, the £100,000 is added to the child's income as it's withdrawn. Withdrawing it all in a single tax year on top of a basic-rate salary would push a large portion into the 40% higher-rate band (which starts at £50,270 in 2026/27), and potentially into the 45% additional rate above £125,140. Spreading withdrawals across several tax years, keeping each year's total income below £50,270 where possible, reduces the overall tax paid substantially.

The April 2027 Pension Change: Why the Gap Is Narrowing

Currently, pensions sit largely outside a person's estate for inheritance tax purposes, which is part of why financial planners have often suggested spending ISA and other savings first in retirement while preserving pension funds to pass on. From April 2027, most unused pension funds and death benefits will be brought into the value of the estate for inheritance tax purposes, similar to how ISA cash is already treated.

This doesn't remove the income tax advantage pensions have (tax-free before 75, taxed as income at or after 75) — but it does mean a large pension pot left to an adult child could, from 2027, face inheritance tax on top of any income tax due, closing part of the gap with ISAs. Anyone doing long-term estate planning around "spend the ISA, keep the pension" should revisit that strategy in light of the 2027 change, ideally with a qualified financial adviser given how estate-specific the numbers are.

Practical Takeaways for Estate Planning

• Spouses: the ISA APS is a genuinely valuable, often underused benefit — make sure any ISA provider is told about it during probate so the tax-free wrapper isn't lost unnecessarily.
• Non-spouse beneficiaries of an ISA: budget for the fact that inherited ISA cash loses its tax shelter immediately and may take years to fully rewrap using your own £20,000/year allowance.
• Pension beneficiaries: check the age at which the pension holder is likely to die relative to 75 when modelling outcomes — it's the single biggest factor in whether withdrawals are tax-free or taxed as income.
• Everyone: from April 2027, don't assume a pension automatically sits outside the taxable estate — get an up-to-date valuation of the full estate, including pensions, when reviewing inheritance tax exposure.