Planning for retirement can be taxing. In this article, we outline what happens to your pension when you die and why it’s important to seek professional pension advice on exactly how much you are able to leave to your loved ones.
For a start, there are several types of pension schemes, for example state, workplace, personal, final salary and defined contribution. There are different rules that need to be explained, information about inheritance tax and beneficiaries to understand. Here are some frequently asked questions.
What happens to my workplace pension when I die?
Most workplace and personal pensions are defined contribution schemes. With these, the amount you’ll end up with at retirement depends on how much you – and your employer if it’s a company scheme – have paid in, where your funds are invested, and how these investments have performed.
If you die before you retire, then usually the value of your savings will be paid as a tax-free lump sum to the pension beneficiary you have nominated.
If you die after you retire, then what happens to your defined contribution pension will vary depending on your age and how you’ve chosen to take an income from it – by purchasing an annuity or using flexi-access drawdown to provide yourself with an income.
What happens to my annuity when I die?
If you’ve chosen to use some or all of your pension to buy an annuity, or income for life, this income will usually die when you do, and no money will pass to your loved ones. However, there are some types of annuity, such as a joint life annuity, which you buy with your spouse or partner, that will continue to provide them with an income after you die.
What happens to my drawdown pension when I die?
If you’re using flexi-access drawdown, where your pension savings remain invested and you take an income from them as and when you need it, then if you die before the age of 75 your dependants can carry on taking an income from your pension free of tax.
However, if you’re older than 75 when you die, your beneficiary must pay income tax on any income they receive from your pension.
Are pension funds subject to inheritance tax?
Drawdown money will be protected from inheritance tax (IHT), as it is considered to be outside your estate. But bear in mind that if you’ve taken money out of your pension before you die, for example to buy investments, this cash will be considered part of your estate and may be liable to IHT. There is no tax on estates valued at up to £325,000 and with the 'main residence' band of £175,000 this gives a total allowance of £500,000 per person. IHT is payable at a rate of 40% of the value of your estate that is above this amount.
What about final salary workplace pensions?
If you are fortunate enough to belong to a final salary scheme, where you receive a guaranteed amount at retirement based on a proportion of your final salary and the number of years you have contributed to your pension, the amount you will leave to loved ones when you die will depend on whether you have started drawing an income from your pension pot.
What other pension inheritance rules apply?
If you die before you’ve started receiving an income from your final salary pension and you have life cover as part of your scheme, usually your beneficiary will receive a lump sum that is typically equivalent to between two and four times your salary. They won’t have to pay any tax on this sum if you die before the age of 75. Depending on the rules of your particular scheme, they could also receive a ‘survivor’s pension’, but this will be taxable.
If you die when you’re already receiving an income from your pot, and again depending on the rules of your scheme, your beneficiary will typically receive a reduced pension until they die.
If you’re unsure what sort of benefits your loved ones will be entitled to when you die, contact your pension provider or scheme trustees and ask them to explain the rules of your scheme to you.
Will my State Pension go to my spouse when I die?
When you die, depending on the amount of National Insurance contributions you have made and when you and your spouse or civil partner reached or reached State retirement age, they may be entitled to extra payments from your State Pension.
For example, if your husband, wife or civil partner reached State retirement age before 1 April 2015, and you have a better National Insurance record than they do, after you die your partner can ask for their pension to be based on your record instead of their own. They may also be able to inherit some of your additional State Pension if you paid into one.
If your spouse or partner reached State retirement age on or after 6 April 2016, usually their State Pension will be based on only their National Insurance contributions. If you’re not sure where you stand, get in touch with the Pensions Service on 0800 731 0469.
The importance of advice
Pension rules can be complicated, so it’s vital to seek professional pension advice if you want to know exactly how much your beneficiaries will stand to receive when you die.
An adviser will be able to check your pension and talk you through your options, as well as make sure your pension costs are kept to a minimum, so that charges don’t eat into your investment returns, benefiting both you and your beneficiaries when you die.
Remember that you should record your wishes in a Will too, so that it’s clear exactly who you want to benefit from your pension and other assets when you die. Although you will usually nominate a pension beneficiary when you sign up to a scheme, spelling out exactly who you want to receive what can save your loved ones considerable stress and anxiety at what will be an emotional and distressing time for them.
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Capital at risk. Past performance is not a guide to future performance. This website does not constitute personal advice. If you are in doubt as to the suitability of an investment, please contact one of Profile Pensions’ advisers. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change.
Telegraph Media Group Limited is an Introducer Appointed Representative of Profile Pensions, a trading name of Profile Financial Solutions Limited, which is authorised and regulated by the Financial Conduct Authority. FCA Number 596398. Registered in England & Wales, Company Number 07731925. Registered Office address: Norwest Court, Guildhall Street, Preston PR1 3NU
Information correct at date of publication.