If you’ve been working hard to build a sizeable pension, you may be concerned about what will happen to your savings when you pass away.
With life expectancy on the rise, most of us are likely to live long into retirement, but it’s a good idea to prepare for the worst just in case.
By making sure your pension can be passed onto your loved ones, you can commit to saving for retirement without worrying the money will go to waste.
So, what happens to your pension if you die before you retire?
What happens to a pension when you die?
Thankfully, there are systems in place that allow people to pass their pension to their loved ones, whether they pass away before or during retirement, but the rules aren’t as straightforward as they could be.
Pensions are considered to sit outside your estate, meaning that when you die, your beneficiaries can access your retirement savings without having to pay inheritance tax.
However, as you’ll learn later in the article, in some cases, income tax may need to be paid.
If you pass away, your beneficiaries should contact your pension scheme administrator to find out how they can access your pension.
If you start receiving your State Pension before you pass away, your beneficiaries should contact the Pension Service too. We’ll talk about the State Pension rules in more detail later in the post.
What happens to defined contribution pensions when you die?
The age you are when you pass away influences the rules for beneficiaries looking to access your defined contribution pension.
If you have a defined contribution pension, pass away before you turn 75 and haven’t started drawing your pension yet, this money can be passed to your beneficiaries tax-free. In most cases, these private pension payments can be taken as a lump sum, invested in drawdown or used to buy an annuity.
It’s important for your beneficiaries to know they have just two years to claim your pension. If they try to claim it after two years, it may be taxed.
If you have a defined contribution pension, die before you turn 75 and have already started using your pension, the way you chose to access your pension will determine how your beneficiaries can access it.
For example, if you withdraw a lump sum and you have money in your bank accounts in addition to your pension, the lump sum will form part of your estate and it may be taxed.
If, however, you’ve opted for pension drawdown, your beneficiaries can access the remainder of your pension tax-free. They’ll have some flexibility here and can draw down payments, take a lump sum or buy an annuity.
However, annuities are never straightforward, and they can be even more complicated when accessing money from a lost loved one.
If you’ve already purchased an annuity before you die, this can rarely be passed to a beneficiary. But there are certain types of annuities that could be passed on, such as joint life, value protected and guaranteed term annuities.
To find out if your annuity can be passed over, your beneficiaries should contact your annuity provider.
If you have a defined contribution pension and die after your 75th birthday, your beneficiaries will need to pay income tax on the remainder of your pension. This will be charged at their own marginal rate of income tax. In some cases, a large lump sum death benefit could move them into a higher tax bracket.
What happens to defined benefit pensions when you die?
Defined benefit pensions operate differently as their value is tied to your salary and the number of years you’ve worked for your employer.
If you have a defined benefit pension and pass away before you retire, your beneficiaries will usually receive a lump sum worth 2-4 times your salary from your pension provider. If this happens before you turn 75, the payment will be tax free. Often, there’ll also be what’s known as a ‘survivor’s pension’ and this will be paid to a spouse, civil partner or dependent child. However, this will be taxed at their marginal rate of income tax.
If you die after you retire, your spouse, civil partner or dependent will usually receive a pension but at a reduced rate.
Is it possible to pass on a State Pension when you die?
It’s possible to pass on your State Pension payments to your spouse or civil partner when you die. Unfortunately, you cannot pass them onto a parent, sibling, child or friend.
The exact rules surrounding State Pension payments after death depend on your age. If you reached State Pension age before 6th April 2016 and receive the Basic State Pension, your spouse or civil partner can claim your Additional State Pension, which is based on your history of National Insurance contributions.
If, however, you reach State Pension age after 6 April 2016 and are eligible for the new State Pension, your spouse or civil partner may inherit an additional payment on top of your pension.
The rules for this are complex, but you can learn more on the government website.
How to make your loved ones’ lives easier
Pension rules have never been straightforward and as you can see, they only become even more complicated when it comes to passing your pension onto loved ones.
Make your loved ones’ lives easier by drawing up a will and nominating beneficiaries. This process will make it clear how you’d like your assets to be divided and who will get what.
It’s also wise to reach out to your pension provider to pass on the contact details of your nominated beneficiaries. If you also own any private investment accounts or use investing apps, check to see whether they have a beneficiary system in place. If not, find out if they have processes in place that allow the administrator of your estate to reach out to them. Death certificates and other relevant documents may be needed to access your investments.
Another step you can take is to put together a folder of important documents. Sit down with your most trusted family member and explain what they need to do to access your money when you’re no longer around. You don’t need to know the rules inside out yourself, but you do need to tell them who they can call to get the ball rolling.
This article was prepared by AdvisorStream and is legally licensed for use by AdvisorStream.
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