What happens to my pensions when I die? Heritage Financial

What happens to my pensions when I die?

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    If you save and invest wisely, your pension is likely to become one of your biggest assets and may even be worth more than your home! Providing your pension has the right death benefits, it means you could leave a very valuable nest egg to your loved ones when you’re gone.

    If you have a Defined Contribution pension, your beneficiaries can usually receive your pension pot when you die. If you die before the age of 75, withdrawals are tax-free. Death benefits for a Defined Benefit pension are different and depend on the rules of your provider.

    In this article, we’ll explore the benefits of a death benefit pension in more detail. For personal advice on what pension is best for you, please contact the experts at Heritage Financial Planning to arrange a callback.

    Defined Contribution pension

    As to what happens to your pension when you die, for Defined Contribution (DC) pensions, such as a private pension or self-invested personal pension (SIPP), the answer depends on the age at which you pass away. Let’s look at an example to demonstrate the point.

    Death Before age 75

    After a lifetime of sex, drugs and rock and roll, Harvey passes away early at age 68 with a remaining personal pension of £200,000. He has previously taken several drawdowns and leaves a written expression of wish that states his daughter, Kelly, is to receive his pension fund when he dies.

    As Harvey died before age 75, Kelly is entitled to receive the remaining money from the pension fund completely tax-free.

    As Harvey’s personal pension facilitates drawdown and beneficiary drawdown, this means Kelly can take the whole £200k as a lump sum tax-free, or she can choose to take smaller tax-free lump sums as a regular income. The latter option means she can potentially benefit from investment growth. 

    The options available to your own beneficiaries depend on your particular pension scheme rules. It’s important to be aware if your pension scheme allows flexi access drawdown or not, as some workplace pensions and older pension schemes do not facilitate it. If not, the beneficiaries will likely be limited to taking the remaining pension pot as a lump sum or even converting it to a guaranteed income in the form of an annuity.

    Death after age 75

    Now what happens if Harvey dies after age 75?

    Kelly would again be able to inherit the pension pot, but any withdrawals would be taxable at her marginal rate, and she would have to pay income tax on any withdrawals.

    As a Basic Rate taxpayer, if she took £10k withdrawal from the pension, she would be left with £8k after £2k tax is deducted. 

    What is an Expression of Wish, and why is it important?

    It is very important to complete an ‘expression of wish’ form and nominate a beneficiary. The trustees of your pension scheme then have discretion on who to give the benefits to, but they will usually follow your wishes.

    This discretion is very important, as pensions, in most cases, do not usually not form part of your estate, and you do not have to pay Inheritance Tax on the value of your pension.

    This is very important. If you have completed an expression of wish, then your pension pot will not be included as part of your estate and will not be subject to inheritance tax.

    This is why many of our clients with sizeable estates choose to run down their other assets, such as ISAs, cash and rental properties, whilst leaving their pensions intact, leaving a more valuable inheritance for their families or other beneficiaries. 

    What happens if I don’t complete an expression of wish?

    If you don’t have an expression of wish form completed, it can be more subjective when you die. Your pension provider may just pay the proceeds out at their discretion. Or, they could just pay the proceeds to your estate as a lump sum, in which case the funds would form part of your estate and may be subject to inheritance tax, along with your other assets.

    That is why it is always good practice to complete and update your nomination form with your pension provider and even have alternative beneficiaries named in case your primary beneficiaries predecease you. 

    What happens to a Defined Benefit pension when you die?

    If you have a Defined Benefit (DB) or ‘final salary’ pension, then the situation is slightly different, and the death benefits depend on your pension scheme rules.

    If you are still an active member of your employer’s DB scheme, then you are known as an ‘active member’. If, on the other hand, you have left the employer who offers the DB scheme, then you are a deferred member.

    You will often hear this referred to as a ‘frozen’ pension, although this is not strictly true as the benefits you have built up will still increase, which is usually with a form of inflation.   

    Let’s explore the pension death benefits before and after retirement.

    Post Retirement Death Benefits

    If you pass away after you have retired and are drawing your DB pension, then just as before retirement, the scheme may pay a ‘dependent pension’, which is paid in the form of a regular income.

    This can be paid to anyone who is a dependent of the scheme member at the time of the death. The classification depends on the scheme, but this usually covers; a surviving spouse or civil partner, children under the age of 23 in full-time education, or anyone who may be deemed, in the opinion of the trustees, to be financially dependent on the member at the time of the death.

    The income is usually received as a reduced pension and expressed as a percentage of the regular income at the date of death. 50% is quite common, but it can be more or less than this and even be a monetary amount in rare cases.

    It’s worth noting that a dependent pension could stop if you remarry or enter a new civil partnership, just as a dependent child pension would cease when they’re no longer deemed to be dependent or beyond a certain age. 

    You may be wondering if this covers you if you do not have a spouse or civil partner but live with your partner and split the bills etc. Again, it depends on the scheme, but usually, this clause would. If you have both a surviving spouse and dependent children, then usually, they will just pay the pension to the spouse.  

    Example:

    Claire retires to the Cotswolds to enjoy her retirement and takes her DB pension benefits. This pays her an index-linked pension, which is a fancy term for a pension linked to a form of inflation such as RPI or CPI.

    Post Retirement Death Benefits

    Her pension pays her £20k per year, and a spouse pension of 50% is attached to it. She is married to Phil, and she sadly passes away at age 70.  

    In this example, Phil is entitled to half of the pension at the date of death, which is an index-linked pension of £10k a year. Once he passes away, the pension will likely die with him. 

    Pre Retirement Death Benefits

    It’s possible for your beneficiaries to get a lump sum payment if you die, but this full death benefit is usually only reserved for current employees and active members of the scheme.

    The beneficiary typically receives a multiple of the salary, say 4 times, but it can be more and less than this. If this is from a Death in Service policy, which it usually is, then before age 75, the lump sum is tax-free.

    In the very unlikely event that you are still employed past the age of 75, then the whole payment would be taxable at the beneficiary’s rate of tax.   

    What is the tax treatment of a DB-dependent pension

    Unlike a DC pension, even if you die before age 75, a DB-dependent pension is treated as earned income for the recipient. The pension scheme administrator deducts any income tax due under PAYE.  

    Like annuities, DB pensions also can have a minimum guarantee period so that even if the member dies, the scheme will continue to pay out the full pension for a certain period, which could be five years. 

    What happens to an annuity when you die?

    If you have an annuity that is in payment, it will depend on the options you chose when you took out the annuity. You can usually set up the annuity based on a single life basis or choose a product that has some form of guarantee, such as a survivor pension. This is paid as a percentage of your pension, usually at 50%, but it will depend on the details of your policy. It is also possible to add a guarantee to ensure the annuity is paid for a minimum number of years at the full amount, such as 5/10 years, even if you die.  

    The guarantees come at a cost, however, as the amount of income received will be less than a comparable annuity on a single-life basis.

    What happens to my state pension when I die?

    In most cases, the state pension will die with you. However, in some instances, your spouse or civil partner may inherit some of your state pension when you die.

    This depends on many factors, such as:

    • When you reached state pension age
    • Your National Insurance contributions
    • The age at which you died

    The state pension death benefits can be complex. You can find out if you are entitled to any of your spouse’s or civil partner’s state pension at gov.uk.

    Conclusion

    In brief, your pension’s fate after your passing hinges on whether it’s a Defined Contribution (DC) or Defined Benefit (DB) scheme.

    For DC pensions, if you pass before age 75, your beneficiaries can receive the remaining funds tax-free. After 75, withdrawals are taxed. An ‘Expression of Wish’ form is pivotal; it guides trustees on distributing benefits tax-efficiently. Without it, outcomes can be uncertain.

    DB pensions have different rules: post-retirement, dependents may get a portion of the pension, while pre-retirement, a lump sum may be paid tax-free before 75 – but it depends on the rules of the pension scheme. Make sure you comprehend your pension’s specifics to secure the best outcome for your loved ones.

    Contact us for pensions advice

    If you are unsure about your options for retirement planning, then the experts at Heritage Financial Planning can help.

    Contact us to arrange a callback from a friendly, knowledgeable financial adviser.

    You may also be interested in the Heritage guide to pensions and retirement.

    Alex Norman-Jones​

    Alex Norman-Jones​

    I am one of the founders of Heritage and I am highly motivated to deliver bespoke financial planning solutions to my clients.

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