Basically – what happens to my pension if I die ?
This is a common question asked by individuals as part of their current and future financial planning. As most people would like to leave some pension provision to a spouse or children in a worse case scenario.
A common misconception is that the pension pot may disappear with them and go to the government or the state. Or stay with the pension provider and added to other assets they hold.
It basically depends upon what type of pension scheme you have or belong to. You either have a Defined Benefits (DB) or Defined Contribution (DC) pension.
A Defined benefit scheme is based on 3 things being salary, length of service and rate of accrual, so the pension is guaranteed by the sponsoring employer.
A Defined contribution is based on the investments held within the pension plan and will go up and down on a daily basis. Dependent on where the investments are held within specific funds.
What are the benefits of having a pension ?
The aim of having a pension is to provide an income later in life to fund your retirement, after you may leave employment. At present you can access a pension from the age of 50 if you have ill-health or protected age. Or 55 in normal circumstances known as (MPA) minimum pension age, although this will increase in April 2028 to age 57. With the idea that it will be 10 years lower than the state pension age (SPA) currently in place.
At present, pension benefits are normally placed in a tax free wrapper, so whilst growing all growth, dividends and gains are free from income tax. But they are also sheltered away from inheritance tax (IHT).
Who can receive benefits on my death ?
Currently any family members such a spouse, children, grandchildren, brothers and sisters etc. can inherit a pension. A member will normally complete a nomination form or expression of wishes form, with their pension provider to simplify matters moving forwards. It is a simple A4 form, that can be completed by hand, or done via online account and can be updated if circumstances change.
If the member doesn’t complete a nomination form, it may delay the payment being made to potential beneficiaries. Or it could be paid at the discretion of the pension provider to the scheme trustee’s running that specific pension.
Ideally a member can nominate whoever they want to receive such funds as part of future planning. The pension provider will normally act in accordance with the members wishes, after making such initial enquires.
By nominating someone in future to receive any funds left in the pension pot, it could given them flexibility as to what decisions they make about how they may access the pot.
An individual may buy an annuity on joint life basis to cover a spouse, or they may buy one for a fixed term period. To offer some protection to loved ones for a specific period of time. Or they may put the funds into drawdown (FAD), so any remaining funds in the pot on death may be passed onto family members.
For FAD, it could be paid as a one-off lump, a beneficiary’s annuity plan or as a beneficiary’s drawdown plan. All providers will have different rules and conditions so check with each relevant provider about the options available.
What about the tax implications ?
If you die under the age of 75:
If somebody dies under the age of 75, then any income or lump sum inherited is normally paid free of income tax. As long as they act within 2 years of the death, and let the provider know of their intentions.
If you die over the age of 75:
If somebody dies over the age of 75, then any income or lump inherited will be paid to the beneficiaries. But it will be classed as taxable income and would be added to other income they receive that year.
This action could push an individual into a higher tax bracket, so it may be useful to consider how you may access that pot. Also, do some tax calculations on the pension provider’s website or gov.uk tax calculators to avoid any unpleasant surprises. There may be no legal way to avoid paying taxes, but you may want to stay at 20% (basic rate) than paying 40% (higher rate) or even 45% (additional higher rate). Any income would normally be taxed at source directly by a pension provider and they will also notify HMRC.
So give careful consideration of how you may access the funds in future, do you really need all that money in one go. Plus, where may you invest that money, as you may be limited in contributions, of investing any windfall elsewhere into different financial products. A simple example you could invest the funds into an ISA (Individual account) but you are limited to £ 20,000 each tax year.
As part of my daily job speaking to clients as part of future planning, I say to them don’t feel under pressure to make any hasty or rash decisions. But make sure, if someone is under 75 when they die, I re-affirm that the beneficiaries act within the 2 year window for it to remain tax-free.
Greater information can be found on the Moneyhelper.org.uk website via: https://www.moneyhelper.org.uk/en/pensions-and-retirement/taking-your-pension/looking-after-your-partner-or-dependants-in-retirement
What about inheritance tax ?
As stated above the funds held within a pension are normally ring-fenced and free from inheritance tax. Once they come out of the pension pot, the funds could form part of your estate and added to other assets you held.
Which could then create an IHT problem, so it may be worthwhile to consider what other assets a beneficiary may hold. You may own a large property, business or have substantial assets already.
It may well be that you spend the money, so it doesn’t become a problem. You are free to do whatever you want with that money, such as holidays, travel, new car, school fees, home improvements or pay off your existing mortgage to name a few examples.
You could also gift that money to other family members, to pass wealth around the wider family. You can give annual gift allowances to £ 3,000 per annum to individuals or larger amounts but you then have to live at least 7 years to fully avoid tax implications.
What about the circumstances of the beneficiary ?
The beneficiary is question could use the funds to buy an annuity, which will provide a secure and guaranteed income for lifetime or a fixed term period. So they can just switch off from and don’t have to worry about making any future investment decisions.
They may control the pot on their own terms via Flexible access drawdown (FAD) or a number of lump sum (UFPLS). Whereby the pot may run out in the future say 10 or 15 years down the road, But they have controlled the pot on their own terms, it will be subject to fees and charges and investment risk but it gives someone flexibility over how they access a pot in future.
It may well be that a beneficiary doesn’t need to access an inherited pension pot. There is nothing stopping them leaving the funds untouched and the funds could be passed onto family members at a later date.
Greater deaths about gifts and annual allowances can be found on gov.uk website via link:
https://www.google.com/url?sa=t&source=web&rct=j&opi=89978449&url=https://www.gov.uk/inheritance-tax/gifts&ved=2ahUKEwjy1K7QoZyIAxWOUkEAHb4uOdgQFnoECB4QAQ&usg=AOvVaw2xvTOVPgBTRESXqbbNpC1o
If you found the above information useful, if wish to check out my blog for other posts about pensions. check them out on https://www.monyeminted.co.uk
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