Understanding Pension Death Benefits: What Happens to Your Pension When You Die?
Death is an inevitable part of life and it's essential to know what happens to your pension when you die. This guide will provide you with all the information you need to understand what happens to your pension when you pass away, and the tax implications of passing it on to your beneficiaries.
Defined benefit or defined contribution pension
The type of pension you have will determine how your beneficiaries will receive your pension. There are two types of pensions: defined benefit and defined contribution pensions.
Defined benefit pension
A defined benefit pension is a retirement income based on your salary and the length of time you were a member of your employer's pension scheme. These pensions include 'final salary' and 'career average' pension schemes. Generally, these are now only available from public sector or older workplace pension schemes.
What happens to defined benefit pensions?
If you have a defined benefit pension, any money to be paid to your beneficiaries will be as outlined in the scheme's rules. Your pension administrator will pay a dependant's pension to your spouse or civil partner, your child(ren), or anyone who was financially dependent on you when you died, including 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 getting (or would have got if you die before your pension started being paid). Any income paid to a dependant will be taxed as earnings at their marginal rate. If the pension payable is fairly small, it might be possible to take it as a lump sum instead.
Lump sums
The following lump sums might be paid to your beneficiaries when you die:
Death in service lump sum: If you die while an active member of your defined benefit pension scheme, your beneficiaries might get a lump sum. This is often a multiple of your salary. This is paid tax-free if the member died before their 75th birthday. This is unless they died before the age of 75 and the amount wasn't paid out before the end of a two-year window period after their death.
Refund of member contributions: Defined benefit pension schemes might also pay a refund of the contributions paid by the member, if the member dies before starting to draw their pension. This is subject to the scheme's rules.
Pension protection lump sum: If your pension is being paid, there's often a guarantee period (usually 5-10 years). If you die within the guarantee period, a lump sum might be paid to your beneficiaries. This lump sum is usually the value of the pension payments that are due to be paid between your death and the end of the guarantee period. This is paid tax-free if you die before the age of 75. Otherwise, it's taxed as earnings on the person(s) receiving it. There might be Inheritance Tax too, as these payments form part of your estate.
Trivial commutation lump sum death benefit: Dependants who are entitled to receive a pension when you die might be able to opt to receive a one-off lump sum instead of a regular income. This may be paid when the value of a dependants' pension or remaining guaranteed instalments of the pension is no more than £30,000. This is usually an option if the dependant's pension is fairly small and is taxed at the recipient's marginal rate of income tax.
Defined contribution pension
A defined contribution pension allows you to build up a pension pot to pay you a retirement income based on how much you and/or your employer contribute and how much this grows. This is also known as a 'money purchase' scheme. They include workplace and personal pensions.
What happens to defined contribution pensions?
If you die and you still have money in your pensions, there are a number of options as to how it can be paid out. The tax position depends on:
Whether or not you have reached the age of 75
Whether the money is in a drawdown account or an annuity
Whether you have nominated beneficiaries
Let's take a closer look at each of these points.
Age
If you die before the age of 75, your beneficiaries can usually inherit your pension pot tax-free. This is because defined contribution pensions are normally outside your estate for inheritance tax purposes.
If you die after the age of 75, your beneficiaries will have to pay income tax on any money they receive. The tax rate they pay depends on their income tax band.
Drawdown or annuity
If you have a drawdown account, your beneficiaries can inherit the remaining pot tax-free if you die before the age of 75. They can either continue to take income from the drawdown account or take the remaining pot as a lump sum.
If you have an annuity, your beneficiaries may be able to receive a lump sum payment or a continuing income from the annuity. However, this depends on the type of annuity you have and whether or not you have nominated beneficiaries.
Nominated beneficiaries
If you have a defined contribution pension, you can usually nominate one or more beneficiaries to receive your pension pot when you die. This can be done by filling in an 'expression of wishes' form with your pension provider. It's important to keep this form up to date so that your pension pot goes to the people you want it to.
If you don't nominate beneficiaries, your pension pot will be paid to your estate and subject to inheritance tax.
FAQs
Q: What happens to my pension if I die before I retire?
A: If you die before you retire, the pension you have accumulated will usually be paid out to your beneficiaries. This can take the form of a lump sum payment or an ongoing pension to your spouse, civil partner, or dependants. The exact rules and options available depend on the type of pension you have.
Q: Can I choose who receives my pension when I die?
A: If you have a defined contribution pension, you can usually choose who receives your pension when you die by completing a nomination form. However, if you have a defined benefit pension, the rules of the scheme will dictate who can receive a pension.
Q: Is my pension subject to inheritance tax when I die?
A: Your pension is generally not subject to inheritance tax when you die, as it is considered a separate asset from your estate. However, if you die after the age of 75 and your beneficiaries receive a lump sum payment or ongoing pension, this may be subject to income tax at their marginal rate.
Q: Can I pass on my pension to my children when I die?
A: Yes, if you have a defined contribution pension, you can usually nominate your children as beneficiaries to receive your pension when you die. However, if you have a defined benefit pension, the rules of the scheme will dictate who can receive a pension.
Q: What happens to my pension if I die after I retire?
A: If you die after you retire, your pension will usually continue to be paid to your spouse, civil partner, or dependants, depending on the rules of your pension scheme. If you have a defined contribution pension, any remaining funds may be paid out as a lump sum to your beneficiaries.
Conclusion
In conclusion, it's important to understand what type of pension you have and how your beneficiaries will receive your pension when you die. By keeping your expression of wishes up to date, you can ensure that your pension pot goes to the people you want it to.
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