The question ‘What happens to my pension when I die?’ may have crossed your mind before, and you would not be alone. This is a very common question. However, the answer may not be as simple as you would have thought.
Given it’s a question related to pensions, things are never quite that straightforward, with a multitude of answers and complexity depending on your age, the type of pension plan and whether your pension is in payment or not. Here, I am going to summarise this complex topic to give you more of an understanding of where your pension will go in the event of your death, and that main considerations you should be aware of.
Death Benefits for pension plans are typically free of Inheritance Tax (IHT), regardless of how the benefits are taken. Again, however, this is pensions, so there are always some caveats and potential tax consequences to consider, so worth talking to your financial adviser about this first.
Things to consider before accessing your pension benefits.
If you are yet to start taking any benefits, are still contributing to your pension plan, or you are below age 55 (generally the earliest you can access your pension plan), we need to look at the two main types of pension plans separately:
1. Defined Contribution Pensions: Also called Money Purchase, this type of pension includes different types of plans such as Self Invested Pension Plans (SIPP), Group or Individual Personal Pension Plans, and most new workplace pension schemes.
These pensions usually pay out the value of your pension pot at the date of your death and, in most cases, are free of IHT. This is because the pension provider normally has discretion over the payment of the benefits. These are payable as a tax-free lump sum to the recipient (provided you are under the age of 75 at time of death).
Nominate your beneficiaries: - As the pension provider has discretion over the payment, it is important to ensure that your wishes and considerations are taken into account regarding where and to whom you want these death benefits to be paid. Ask your pension provider for an expression of wishes form (Death Benefit Nomination form) for you to complete and return to the provider to keep on their records. If you have more than one pension you will need to let all your providers know.
This form details the names of the individuals (beneficiaries) who you would like the money to be paid to in the event of your death. Most pension plans now allow anyone to inherit your pension death benefits so they don’t necessarily have to be your spouse, civil partner and children. It’s also possible for death benefits to be paid directly into a Trust you have set up.
2. Defined benefit schemes: Often referred to as ‘Final Salary’ or ‘Career average’ pension schemes. These have historically been provided by larger employers but generally now only offered by civil service and public sector employers.
These types of pension schemes provide a dependent’s pension, normally paid to a spouse, civil partner and any dependent children. The scheme may also pay to another adult who is financially dependent upon you. This is paid in line with the scheme rules, so don’t assume anything and be sure to check with your pension scheme provider.
Finally, if you’re still employed and contributing to a workplace pension, you may also have some form of life cover from your employer.
For expert advice on financial matters why not book a call with a Financial Adviser from Integrity365. Email Integrity365 directly for more information.
Things to consider once you have started taking your pension benefits.
For those of you who have started taking some benefits from your pension plan, even if you have only taken the tax-free cash available, we need to look at some examples of different types of pension plans in payment.
Generally, in the event of death before the age of 75, your beneficiaries receive any continued income, free of income tax. Death after the age of 75 means that the beneficiaries pay income tax based on their margin tax rate.
Annuity (guaranteed income for life): Which death benefits are paid very much depends on how these plans were set up at outset. Some annuities include a guaranteed pension period, typically 5 or 10 years. If you die before the end of the guaranteed period, the balance of any pension income (annuity) due continues for the remainder of the term.
Joint annuity: These ongoing payments continue to your spouse, for their entire lifetime after you die. When your spouse dies, the income ceases and cannot be left to continue to anyone else (such as children, grandchildren).
Capital protected annuity: Also known as a ‘value protected’ annuity. Your beneficiaries inherit a lump sum, being the value of your initial pension pot less the amount of any annuity payments you took before you died.
Flexi access / Drawdown plans: This is a popular and relatively new type of pension plan, introduced during the advent of ‘pension freedom’ legislation in April 2015. It’s a way of using your pension pot to provide you with an income. There is no limit on how much income you can choose to take from your drawdown funds. The income you get will vary, depending on the fund’s performance and how much you withdraw from the pot. This means that your income isn’t guaranteed for life.
In the event of your death, it is possible to nominate anyone, not necessarily a dependent, to benefit and inherit the remaining pension funds. Your nominated beneficiary then has three options:
- to take this amount as a one-off lump sum payment;
- to use the remaining pension pot to purchase an annuity, which is guaranteed income for life;
- keep the pension pot invested in drawdown to continue taking an income.
This Drawdown option has opened a new intergenerational planning option with the ability for individuals to pass on their remaining pension pots, in the event of death, not only to their spouse but to grown-up children, grandchildren and in fact anyone else they want to benefit. As the remaining funds are held within a pension wrapper it also means that the inherited pension pot remains outside the estate for IHT.
Why lifetime allowance is another option
One last area of consideration is the awareness of the Lifetime allowance, currently set at £1,073,100. Your beneficiary might pay extra tax if the amount you take from your pot before you die plus the amount you leave behind is more than £1,073,100.
If you are in any doubt or would like to discuss your own pension plans in depth, get in touch with an Independent Financial Adviser who can talk you through your options.
Written by Peter Matthews ACII FPFS, Independent Financial Adviser/Chartered Financial Planner, Integrity365.
Customer service is at the heart of everything Integrity365 do, from the early days of pensions and ISAs to investments and lump sum decisions, through to retirement and later life planning, they are here to support you through the key stages of your life with a holistic approach to financial planning.