What happens to your pension when you pass away?
As you plan your will, it’s natural to start thinking about what might happen to your pension when you pass away, and what the tax implications of passing on your pension to a loved one. How your workplace pension or a pension that you’ve set up yourself may be paid to your beneficiaries when you pass way depends on what type of pension you have.
State Pension
Your State Pension will normally stop being paid when you die. However, your spouse or civil partner may be able to inherit some of your State Pension if they meet certain historical criteria, which applied before the new State pension rules came into force on 6th April 2016. This impacts a very small and deceasing population, so we won’t go into detail about these rules.
Defined Benefits Pension
If you have a defined benefit pension, any money to be paid to your beneficiaries will be as outlined in the scheme’s rules. It’s best to check with your pension administrator to find out what your beneficiaries might be entitled to when you die, as the rules of each scheme are different.
Your pension administrator might pay a dependant’s pension to:
your spouse or civil partner
your children, providing they are under the age of 23 and in full-time education
your children, regardless of age, if they’re mentally or physically impaired
anyone who was financially dependent on you when you passed away, which may include a partner you weren’t married to or in a civil partnership with.
The pension they will get will be a percentage of the pension you were receiving (or would have received if you pass away before your pension started being paid). Any income paid to a dependant will be taxed as earnings at their marginal rate. In addition, if the pension payable is fairly small, it might be possible to take it as a lump sum instead.
Defined Contribution Pension
If you have a defined contribution pension, the options depend on whether any funds have been drawn from the pension when you pass away and whether they have been used to purchase an annuity.
If no money has been taken from the pension: Your beneficiaries can usually withdraw all the money as a lump sum or they can set-up an annuity to receive a guaranteed income.
If you have a flexible retirement income and are in pension drawdown: Your beneficiaries can take the remaining money left as a lump sum or they can set-up an annuity to receive a guaranteed income.
If you set-up an annuity to receive a guaranteed income: What is payable will depend on the options you selected when you set the annuity up. If you opted for a single life annuity, any payments stop when you die, whereas if the annuity is set-up on a joint life basis, your beneficiary will continue to receive a proportion of the income you were receiving. There may be further payments if you had a guarantee period and passed away within the guarantee period, in which case, payments will continue to your beneficiary until the end of the guarantee period.
Inheritance Tax
Normally, your pension will not be part of your estate and will not be taxed when you die. For this to happen, the pension scheme administrator must have the discretion to decide to whom the benefits are paid. Most pension schemes are set-up as discretionary trusts, which means the trustees/providers have the right to choose who ultimately receives anything that is payable from the pension when you pass away, usually based on a pre-defined set of rules.
It is important to check the rules of your pension scheme to check if your pension may be subject to any tax when you pass away. You should also speak to a financial advisor if you have any doubts or queries that are specific to your pension scheme.
