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Table of Contents
- What happens to a final salary pension when you die?
- What happens to a defined contribution pension when you die?
- What happens to an annuity when you die?
- Summary of the tax beneficiaries pay on defined contribution pensions
- What are the rules around pension inheritance tax?
- Nominating who gets your pension when you die
- What happens to your state pension when you die?
Knowing what will happen to your pension when you die is important to understand whether those you leave behind can rely on something meaningful financially being passed on to them from your pension.
What happens to your retirement savings depends on a number of factors, including your age, the type of pension you have, and whether you have started taking money from your pension. Read on to learn more about the pension rules after death for different pension schemes and how you can help decide who gets your pension when you die.
What happens to a final salary pension when you die?
If you have a defined benefit or final salary pension, your scheme may pay a ‘dependant’s pension’ to a spouse or civil partner and sometimes children that are financially dependent on you. Scheme rules vary, so it is important to check what your beneficiaries might be entitled to.
The amount they receive will be less than what you were being paid, or would have received if you haven’t started taking benefits. Recipients of a dependant’s pension will pay tax on this money in line with their marginal rate of income tax.
If the pension a dependant is due is relatively small, and valued at less than £30,000, trivial commutation rules might provide the option for it to be taken as a lump sum payment rather than an income. A lump sum might also be an option should your pension include a guarantee it will pay out for a certain amount of years, and you’re receiving payments within this period when you die.
A tax-free death-in-service lump sum may be paid if you die before age 75 and are still an active member of the scheme. How much your beneficiaries receive is normally linked to your earnings (for example, a multiple of your salary).
Some defined benefit schemes also allow for your contributions – and sometimes interest on these payments – to be refunded to your beneficiaries if you die before accessing your pension.
What happens to a defined contribution pension when you die?
With a defined contribution scheme, beneficiaries can have various options over a pension they inherit.
If you haven’t yet taken any money from your pension or are in pension drawdown, your beneficiaries typically have the choice of taking the pension you’ve left as a one-off lump or using the funds to buy an annuity to secure an income for themselves. Some providers will offer beneficiaries pension drawdown as a third choice; if they don’t, transferring to a scheme that does may be worth considering.
If you are under 75 when you die, beneficiaries won’t generally have to pay income tax on the pension benefits that they take, provided the pension benefits are paid within two years of your death. If you are over 75 at your death, tax will usually be payable at their marginal rate.
What happens to an annuity when you die?
If you have bought a traditional pension annuity with your pension, generally this cannot be passed on to your beneficiaries, and the payments will stop, when you die. However, there are certain annuities that will offer some protection for a spouse or other financial dependant.
If you purchased a joint annuity, the other person named on the annuity will continue to receive an income until they die, although it is likely to be a reduced amount. Value-protected annuities allow you to safeguard a certain amount of your money, and will pay a lump sum to your beneficiaries on your death provided you have received less than this in annuity payments.
It is also possible to buy annuities with a guaranteed period, which promise to pay your income for a set number of years, even if you die. So if you had a 10-year guarantee and died after five years, payments would be made to your beneficiary for another five years.
Payments from an annuity to a beneficiary will be tax-free if you were under 75 when you died, and taxed at their marginal rate if you were over 75. Payments under a guarantee period may be subject to inheritance tax.
» MORE: All about pension annuities
Summary of the tax beneficiaries pay on defined contribution pensions
| What is being inherited? | Your age when you died | What tax is due? |
|---|---|---|
| A pension you haven’t accessed | Under 75 | Tax-free (if paid within two years of your death) |
| A pension you haven’t accessed | 75 or older | Income tax (paid by the recipient at their own rate) |
| The remainder of a pension you have accessed | Under 75 | Tax-free |
| The remainder of a pension you have accessed | 75 or over | Income tax (paid by the recipient at their own rate) |
| An annuity that is set up to pay benefits after you have died (ie a joint annuity, value protected or with a guaranteed period) | Under 75 | Tax-free |
| An annuity that is set up to pay benefits after you have died (ie joint annuity or one with value protection or guaranteed periods | 75 or over | Income tax (paid by the recipient at their own rate) |
What are the rules around pension inheritance tax?
Generally, pensions sit outside of your estate for inheritance tax purposes. This means the pensions you have won’t be included when calculating the value of your estate to see if it is eligible for inheritance tax.
One exception is if your pension provider has no discretion over who they can pay your pension to when you die. Although you can usually nominate who you would like to receive the proceeds of your pension on your death – and this will usually be followed – a provider must have the right to choose someone else for a pension to be exempt from inheritance tax.
Certain pensions will allow you to choose without question who will receive your pension when you die. But if a pension allows you to make such a definite instruction, and the provider has no discretion, that pension must usually form part of your estate for inheritance tax purposes.
It can be important to think through the implications for tax and estate planning before you take an income from your pension. For example, if you have other savings or investment accounts, you may want to consider using that to provide an income before you dip into your pension. An independent financial adviser (IFA) will usually be best-placed to help you work it all out.
» MORE: Everything you need to know about pension advice
Nominating who gets your pension when you die
When you start a pension you will usually be asked to name someone as your pension beneficiary. This is the person you want to inherit your pension when you die. Although pension trustees and providers have discretion over who they pay pension death benefits to, wishes are generally followed. It is therefore important you share this information with your pension provider, preferably using their own expression of wish form if you can, and that you keep it up to date. You should also include your pension – and who you want to inherit it – in your will. Details of your pensions can be held with your will so that your executors know where to find them.
If no beneficiaries are named for a pension it is up to the pension provider to decide who inherits your pension. This is usually the next of kin and any dependents.
What happens to your state pension when you die?
While your state pension payments will stop when you die, there are instances where a spouse or civil partner is eligible to receive an uplift to their payments based on your state pension.
Eligibility for inheriting state pension, and how much extra might be paid, depends on the level of entitlement each spouse or civil partner has accrued and when you each hit state pension age – more specifically if this was before or after 6 April 2016.
However, working out if you qualify to inherit state pension is complicated, and best explored using this tool on the Government website.
Image source: Getty Images
Dive even deeper
QROPS Explained: Transferring a Pension Overseas
Guaranteed Minimum Pension Explained – What is GMP?
