What Happens to the Money in Your Pension When You Die?
Many people have saved long and hard for their retirement using a pension to invest their money. It’s not only important to think about how your pension can best fund your own retirement, but also to think about how you could pass on your pension to your spouse or partner – or on to the next generation. If you die with money left in your pension pot, you might be able to pass on your wealth to your beneficiaries. The rules surrounding this have recently changed to include some new, exciting developments and opportunities. Let’s consider the different ways you may be able to pass on the money in your pension when your die.
If you die before taking anything from your pension
If you die before taking any money from your ‘defined contributions’ pension, it can usually be passed on tax-free as a lump sum to your spouse, partner or other beneficiaries as long as your total pension pot is less than the ‘Lifetime Allowance’ (current £1m) and you are under 75 years of age.
The way your pension is treated comes down to how old you are when you die.
- If you die before age 75, all benefits can be passed on to any beneficiary (and this can now be anyone including non-relatives) and they will not have to pay any tax on receipt of this money.
- If you die after age 75, the value of your pension can be paid to your beneficiaries and they will pay income tax when they take the benefits.
No inheritance tax is usually payable when passing on a pension pot in this way.
When it comes to ‘defined benefit’ (also known as a ‘final salary’) schemes, the benefits you can pass on vary from scheme to scheme so it’s best to check the rules of your policy carefully or get some expert input.
If you die after purchasing an annuity
An annuity is a guaranteed income for life. Many people use their pension pot to purchase an annuity when they retire. In exchange for their pension pot, an insurance company will provide an income for as long as you live.
Typically, this means that the moment you die, there is no pension to pass on to your beneficiaries.
However, if you choose an annuity with a ‘guaranteed period’ (eg. the first 5 or 10 years) and die within this period, then the annuity will continue to be paid until the end of the guaranteed period.
If you purchase a ‘joint life’ annuity, the income will continue to be paid to your spouse or civil partner until they die. If you die before age 75, the annuity payments paid will be tax-free. If you die after age 75 then your spouse will pay tax on any payments in the same way as any other earned income.
If you die with money in ‘drawdown’
Many more people are now choosing to take their retirement income using ‘drawdown’ as opposed to purchasing an annuity. A drawdown policy allows you to keep your pension invested and simply draw as much or as little as you need. Not only can this mean you have more flexibility on how you draw an income in retirement, it can also mean you are able to pass on your wealth to your beneficiaries in most cases.
If you die before age 75, your spouse, partner, dependant or other beneficiary can:
- Remain in drawdown and take an income tax-free.
- Take the value of your pension as a lump sum tax-free.
- Buy an annuity, where income will be paid tax-free.
If you die after age 75, your spouse, partner, dependant or other beneficiary can:
- Remain in drawdown and take an income. This will be taxed the same way as any earning income.
- Take the value of your pension as a lump sum. This will be taxed the same way as any earning income.
- Purchase an annuity. This will be taxed the same way as any earning income.
One other thing to consider is to ensure your pension is passed on to the right person or people. We all have the opportunity to express to whom we would like our pension death benefits to be paid. This is known as an ‘’expression of wish’. Without this, the pension trustees will have to guess how your benefits are paid out. This might also mean benefits have to be paid as a lump sum instead of staying in the beneficial pension environment.
Beware – not all pensions are created equal
The rules on ‘drawdown’ sound simple enough so there shouldn’t be any potential issues, right? Unfortunately, there could still be some challenges depending on the rules of the pension scheme you are invested in. It is these rules that will ultimately govern what can happen to your money when you die.
If your pension scheme can’t facilitate ‘dependant’s or nominee’s drawdown’, the only option when you die could be to pay a lump sum. Although possibly not ideal, this maybe not too much of a problem if you die under age 75 as there are no tax consequences. However, if you die after the age of 75, the benefits become taxable. Your beneficiaries could pay tax at 40% or higher on the lump sum they receive from your pension. This is probably not what you would want to happen.
If you die while receiving your pension from a defined benefit (final salary) pension
When you die, a defined benefit pension will usually carry on paying an income to your spouse or civil partner but at a reduced rate. The scheme might also pay a pension for any children who are under 18 or are still in full-time education.
The precise benefits vary from scheme to scheme, so check your scheme documents or talk it through with an expert such as a chartered financial planner.
What about your state pension?
Your basic state pension is paid only to you and can’t be passed on to someone else when you die. If you have contributed towards an ‘additional’ state pension, your spouse or civil partner may get some of this.
If your spouse or civil partner is over state pension age when you die, they may be able to boost their own basic state pension by using your ‘qualifying years’ entitlement. – as long as they don’t already get a full state pension.
If your spouse or civil partner is under state pension age when you die, any state pension based on your qualifying years entitlement will be added to their state pension when they claim it. For this to happen they can’t have remarried or formed a new civil partnership by the time they reach state pension age.
If you’ve deferred your state pension and you die, your spouse or civil partner may be able to claim an additional state pension or a lump sum.
So, what do you need to do?
There are a few quick and simple steps that everyone can take to ensure their pension can be used the way they want it to when they die:
- Check the death benefit options your pension schemes allow.
- Make sure your ‘expression of wish’ is up-to-date.
- Make sure your will is up-to-date.
- Get some advice on your options – talk to a chartered financial planner.
The rules around pensions on death have recently changed and it is important you understand your options. Many more people than ever before are passing on their pension to their spouse, partner, children or other beneficiaries.
If you want to discuss your pension death benefits or any other aspect of your retirement planning please get in touch.