One of the most regularly asked questions I get from clients is “what happens to my pension when I die”.
Your pension can be your largest asset, often exceeding the value of your home.
The rules governing pensions can be complex and have changed significantly in recent years.
What happens on death can depend on a few factors including the type of pension your have or the age you die.
Defined Contribution Pensions (DC)
Most people with pension savings have a DC pension. These are accounts you pay into during your working life and the capital value can be converted into an income payment at retirement.
You benefit from tax relief on any contributions you make, and you can start to take benefits from age 55.
Typical examples of DC schemes are personal pensions, including self-invested personal pensions (SIPPs) or workplace schemes where your employer contributes as well.
The rules are fairly straightforward and now more flexible following changes made in 2015. As a result, more people are using DC schemes as a legacy asset to pass on to loved ones.
If you die before age 75, anything in your DC pension can be passed onto any individual and normally tax free providing the payment is made with 2 years of death and the payment is within the member’s available lifetime allowance (LTA).
Any lump sum payment above the LTA will be taxed at 55%. The LTA is currently £1,055,000 although could be higher if you have applied for special protection.
As an alternative to paying the benefits out, the pension scheme administrator, can transfer the benefits to a beneficiary drawdown pension, as long as you have nominated a beneficiary before your death.
A beneficiary drawdown pension has the advantage of future investment growth as well as giving the beneficiary the ability to withdraw any amount at any time tax free. The beneficiary doesn’t have to be of pension age to get the money.
If you die after age 75 any remaining fund can be paid out to beneficiaries but will be treated as their taxable income and taxed accordingly.
If you purchase an annuity (lifetime income), instead of moving into income drawdown, the capital sum is lost but an ongoing income may be paid to your spouse, civil partner or dependent child if this option was selected when you bought the annuity.
Normally a pension fund is not subject to Inheritance Tax (IHT) and therefore can often be used in estate planning to pass wealth on to family tax efficiently.
Defined Benefit Schemes (DB)
If you work in the public sector or for a large PLC you may be a member of a DB (final salary) pension. In this example there is no specific “pot” of money but rather a promise to pay an income at retirement.
If you die before taking benefits, these schemes often pay out a tax free lump sum to your spouse or civil partner as a multiple of your salary. Additionally, a survivor’s pension can be paid which is taxable.