Have you considered what would happen to your pension if life took an unexpected turn? You’ve likely spent years planning and building your financial future—but is it truly secure? Who will benefit from your hard work if you’re no longer here to enjoy it?
These are the tough but essential questions you need to ask as you plan ahead. Understanding how pensions are handled when you pass away isn’t just about peace of mind; it’s also about ensuring the proceeds go where you want them to, which then helps you protect your loved ones and their financial stability. But, before we explore the types of pensions available, let’s address a recent and significant change in the rules relating to – inheritance tax.
What about inheritance tax?
Until now, pensions have generally been exempted from inheritance tax, provided they remain outside your estate, which meant that the funds in your pension could be passed on to your beneficiaries without incurring additional tax. However, in the 2024 Autumn Budget, Chancellor Rachel Reeves announced that from 6 April 2027, unused pension savings will be included in your estate for Inheritance Tax (IHT) purposes.
Currently, unused pensions are typically paid tax-free to beneficiaries at the discretion of Trustees. Under the proposed changes, unused pension savings could be taxed as part of your estate if it exceeds the IHT threshold of £325,000.
To ensure your pension savings are protected and passed on tax-efficiently, consult with a financial adviser. They can help you structure your plan to make the most of the available tax exemptions.
What happens to your private pension when you pass away?
The type of pension you have plays a significant role in what happens if you pass away.
Private pensions, including workplace pensions, offer flexibility when it comes to inheritance, allowing you to pass on financial benefits to your loved ones. The way this works depends on whether you have a defined contribution pension or a defined benefit pension.
What is a defined contribution pension?
Defined contribution pensions are savings-based plans where the value of your pension pot depends on how much you’ve contributed, your employer’s contributions, and investment performance of the funds that the monies are invested in.
Here’s what happens if you pass away before 6th April 2027:
If you’re under 75: The entire pension pot can usually be passed to your beneficiaries tax-free, unless the lump sum exceeds the pension pot owner’s Lump Sum and Death Benefit Allowance of £1,073,100. They can then withdraw it as a lump sum or take regular income, depending on their preference.
If you’re 75 or older: Beneficiaries can still access the funds, but withdrawals will be taxed at their personal income tax rate.
Defined contribution pensions provide flexibility and control over how your savings are passed on, making it vital to keep your nomination forms updated to ensure the money reaches the intended recipients.
However, if you were to pass away after 6th April 2027, IHT may apply regardless of your age when you die.
What is a defined benefit pension?
Defined benefit pensions, often referred to as final salary or career average pensions, guarantee a set income based on your earnings and years of service.
If you pass away before retirement before 6th April 2027:
Dependent’s pension: Your spouse, civil partner, or dependent children may receive a percentage of your guaranteed income, providing ongoing financial support.
Lump-sum death benefit: Some schemes may also offer a one-off payment, typically calculated as a multiple of your salary.
Defined benefit pensions are less flexible than defined contribution pensions, but they offer security for your dependents. It’s essential to check the specific rules of your scheme with your provider.
After 6th April 2027, these types of pensions should not be impacted by IHT, because the benefits stop being paid on death (or death of the spouse).
How can you minimise risk with your pension arrangements?
- Update nomination forms: Regularly update beneficiaries, especially after life changes like marriage or divorce.
- Understand scheme rules: Familiarise yourself with your provider’s rules on lump sums, dependent pensions, and tax implications.
- Communicate with loved ones: Inform beneficiaries about your pension arrangements and provider details to avoid confusion.
- Review regularly: Schedule annual reviews to keep your pension plan aligned with your goals.
- Seek professional advice: A financial adviser can help maximise benefits and ensure tax-efficient inheritance.
What happens to your State Pension when you pass away?
The State Pension operates differently from your other pension arrangements and does not automatically pass on to your beneficiaries. However, your spouse or civil partner may be eligible to inherit certain benefits, depending on the pension scheme you’re under and your National Insurance contributions.
Old State Pension scheme
If you were part of the old State Pension scheme (pre-2016), your spouse or civil partner might inherit:
- A portion of your additional State Pension: This includes the State Earnings-Related Pension Scheme (SERPS) or State Second Pension (S2P).
- Lump-sum payment: Some individuals may also qualify for a one-off payment to support their surviving partner.
New State Pension scheme
For those in the new State Pension scheme (post-2016), inheritance is more limited but still possible:
- Boosted State Pension: Your spouse or civil partner could inherit extra pension contributions if you deferred taking your State Pension or paid additional voluntary contributions.
- Specific inheritance rules: The exact amount they inherit depends on your contribution history and the circumstances of your death.
How can you minimise risk with State Pensions?
- Check your national insurance record: Ensure qualifying years are up to date and consider voluntary contributions for gaps.
- Understand inheritance rules: Learn how your spouse or partner may inherit contributions or benefits under your scheme.
- Plan for early death: If you pass away before reaching State Pension age, inform your spouse about potential inheritance of qualifying years.
- Stay updated with DWP: Keep your contact details updated with the Department for Work and Pensions to avoid delays.
- Seek professional advice: As with private pensions, a financial adviser can help maximise benefits and ensure tax-efficient inheritance.
Don’t leave it to chance, let’s plan your financial future together
Understanding what happens to your pension when you pass away is a vital part of financial planning, but as we’ve explored above, it can vary depending on your circumstances and may at times feel overwhelming – but you don’t have to do it alone.
At Flying Colours, our experienced, independent financial advisers can help you navigate the complexities of your pension arrangements and State Pensions, ensuring your savings are tax-efficient, and giving you peace of mind that your legacy is protected. Contact us today to start planning for your financial future with confidence.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
