We save into our pension pots throughout our working lives, hoping for a comfortable and fulfilled retirement. Your pension is your nest egg, a means of paying the bills and enjoying your third age when you finally stop work. But, have you ever wondered ‘what happens to my pension when I die’?
We’ve touched on building up a pension pot to save for your dream retirement while enjoying life now, as well as what you can expect from the third age in retirement. But our own mortality is not something we like to dwell on, so even though you have retirement all mapped out, you might not know what happens to your pension when you die.
Planning for retirement is tricky enough on its own, but it’s important you also think about what happens to your loved ones after you’ve gone. As ever, it’s not always that straightforward with pensions, and the rules differ depending on the type of pension scheme you have, so let’s break things down a little further.
What happens to my pension when I die?
First things first, there is a selection of different pension schemes, and it’s easiest to look at each separately:
Defined benefit schemes
A defined benefit pension pays you a guaranteed retirement income based on your salary and length of employment. These are also known as ‘final salary’ or ‘career average’ pension schemes.
You don’t accumulate a pension pot as such, just a promise of an income in retirement for the rest of your life.
What happens to my defined benefit pension when I die?
Because you don’t build up a pension fund, there’s no pot to pass on. So instead, money paid to beneficiaries gets outlined in the pension scheme rules. The rules vary for each scheme, so you’ll need to check with your pension administrator.
If you die whilst working from the company, but before retirement, the scheme might pay out a ‘Death in Service’ lump sum, usually a multiple of your earnings at the time. If your death is before your 75th birthday, this lump sum will be tax-free.
If you die after taking your income, most schemes allow a spouse to inherit a proportion (typically 50%) of your income; this is known as a widow/spouse’s pension and taxable at their marginal rate of income tax. There may also be a guarantee period; usually, 5-10 years, which if you die within, a lump sum will be paid to your beneficiaries equal to the amount of your lost income between your death and the end of the guarantee period. If you die before 75, then the lump sum is tax-free; otherwise, it’s taxable at the beneficiary’s income tax rate.
Defined contribution schemes
A defined contribution pension allows you to accumulate money in a pension pot, and the income you receive in retirement depends on how much you save and how much it grows. Also known as money purchase schemes, and typically your workplace pension or personal pension will be a defined contribution scheme.
What happens to my defined contribution pension when I die?
If you’ve got money left in your defined contribution pot at death, then there are lots of options for your beneficiaries. But the tax they pay depends on how old you are when you pass away.
If you die before 75, your beneficiaries won’t pay any income tax on the pension they inherit. But, if you haven’t taken benefits from your pension at this point, then there will be a test against your Lifetime Allowance, so there may be a charge to pay if you exceed this limit.
If you die after 75, any inherited pension will be taxed at their marginal income tax rate. But there won’t be a test against the Lifetime Allowance.
So how do they take these benefits?
Suppose you haven’t taken anything from your pension or have accessed Flexi-access drawdown. In that case, your beneficiaries can usually take the remaining money in your pension pot either as a lump sum, an annuity, or continue taking flexible income (although not all schemes allow this, so it’s worth checking).
If you purchased an annuity at retirement, your beneficiaries’ entitlement depends on the options selected when you set it up. If it’s on a joint life basis, the beneficiary will continue receiving a portion of the income. However, if it’s a single life annuity, the payments would stop.
The only exceptions are if there is a guarantee period and you die within this period, the beneficiary would continue to receive this income until the guarantee period ends. And if you get value protection, the pension can be paid to a beneficiary as a lump sum.
The state pension is a regular payment from the government in retirement payable when you reach State Pension age. It is currently £179.60 a week. Although, the amount you receive can be higher if you have an Additional State Pension or defer taking it. And lower if you have not met the minimum number of 35 years of National Insurance contributions.
You can check your National Insurance record here.
What happens to my state pension when I die?
Usually, your State Pension will stop. Although, there are a few instances where your spouse or partner might be able to inherit a portion of your State Pension. You can check this out here.
Planning to pass on your pension savings
With an estimated 42% of the total wealth of the UK in pension savings, you’ll want to ensure this gets passed on to your loved ones in line with your wishes. But sometimes, it’s hard to know with confidence what will happen to your pension after you die. So here are a few other things we suggest you consider doing to make the most out of your pension pots beyond your lifetime:
Most schemes allow you to state which people or charities you’d like to inherit your pension when you die. However, the process for naming your beneficiaries can vary across different pension providers.
You might be able to name and update your beneficiaries online by logging into your account, or you might be required to request a Beneficiary Nomination (also known as an Expression of Wish) from your pension provider.
Updating your wishes
It’s vitally important you keep your wishes up to date, especially after big life events such as marriage, divorce, having children or losing a partner.
The provider or trustees of a scheme decide on who to pay your pension benefits to, and this is one of the documents they consider in making their decision. But, of course, they have the discretion on who to pay your benefits to, so just because you’ve nominated someone, it doesn’t guarantee they will follow this.
They may also look to your will and see who is financially dependent on you at the time of your death. So, it’s crucial your affairs are kept up to date, especially if your family situation is complicated.
Any assets you own, such as property, savings or cash, form part of your estate when you die, which may be subject to inheritance tax if it goes over certain thresholds and allowances. Most of the time, pensions won’t form part of your estate, but only if the provider/trustees have the discretion to choose who your benefits are paid to on death.
For this reason, pensions are a very tax-efficient way of passing on your wealth since they sit outside of your estate for inheritance tax purposes, and so there usually won’t be any IHT to pay.
As you can see, there are lots of things to consider when considering your contingency plan, and it may be hard to know what the situation will look like with your pensions when you die. If you would like to discuss your finances and later life plans, please feel free to get in touch with us any time to have a chat with one of our independent financial advisers.