Your pension is one of the best tools you have at your disposal when building savings for retirement.
During your working life, you benefit from employer contributions and tax relief on top of your own contributions. You may also see growth as the funds are invested on your behalf.
Eventually, you can draw on this wealth to fund your dream retirement. But your pension still has an important role to play beyond this.
Providing the payment of the death benefits are set up correctly, your pension can also be an effective estate planning tool. Your family do not usually have to pay Inheritance Tax (IHT) on any wealth in your pension, so you may be able to pass on more of your estate to loved ones.
However, it’s important to consider this ahead of time and decide how your pension fits into your estate plan.
Yet, a recent survey reported in PensionsAge found that only 41% of people correctly understand what will happen to their savings when they are gone.
Read on to learn what happens to your pension savings when you die.
Your pension is not covered by your Will
Some people incorrectly believe that their pension is treated in the same way as their other assets when they die. For example, according to PensionsAge, 26% of people surveyed thought that their pension would automatically pass to their next of kin.
You may also assume that the beneficiaries named in your Will could automatically inherit your pension, but that is not normally the case.
In fact, your Will does not usually cover your pension benefits at all, and you may need to choose a beneficiary (or beneficiaries) to inherit your remaining pension funds separately.
The amount that they receive depends on the type of pension scheme you are enrolled in.
An “expression of wishes” form nominates somebody to inherit your defined contribution pension
Most modern workplace pensions are defined contribution (DC) schemes. A combination of your own contributions, employer contributions, tax relief, and potential investment returns make up your retirement savings.
When you reach retirement age, you might decide to use these savings to purchase an annuity or transfer it to drawdown contract and take an income from it. You could also use a combination of drawdown and annuities to generate your retirement income.
You may not spend all your retirement savings, and your loved ones can usually inherit any remaining funds in your pension when you die.
The trustees of your pension scheme ultimately have the final say over who inherits your pension. However, you can fill out an “expression of wishes” form to nominate your chosen beneficiaries. Usually, the trustee will follow these instructions. It is good advice to check your pension has an expression of wishes in place and that it matches your current requirements. If you have not nominated anybody, your pension savings may be inherited by somebody who you did not intend to receive them.
When they receive the funds, your beneficiary (or beneficiaries) can normally choose to take a lump sum, draw an income from the pension, or use it to purchase an annuity. In some cases, they may also be able to transfer the money into a different pension scheme.
Alternatively, they could leave your pension savings invested in the current scheme. This may be beneficial for their own estate planning as they might be able to pass the funds on without IHT.
If you die before the age of 75, your beneficiaries will not usually pay tax on the funds they inherit. However, if you die after 75, they may pay Income Tax at their marginal rate when drawing from an inherited pension.
Additionally, any payments your beneficiaries receive are normally free from IHT as long as they are “discretionary” – the trustee of your pension scheme can choose whether to pay it to your beneficiaries. This is often the case if you fill out an “expression of wishes” form.
Defined benefit pensions each have their own rules about what happens when you die
Defined benefit (DB) pensions have become less common these days, due to the costs of employers funding them, but you may have one if you are a public sector worker or have an older workplace pension.
This type of pension normally pays a retirement income based on your salary and the number of years you worked for that employer. This includes “final salary” or “career average” pension schemes.
Each DB scheme has its own rules about what happens to any remaining funds on your death. So, you may need to check with your pension administrator to find out what your beneficiaries are entitled to. You will also need to nominate who you want to inherit your pension.
Your pension provider may continue making payments to:
- Your spouse or civil partner
- Children, provided they are under the age of 23 and in full-time education
- Children of any age if they are mentally or physically impaired
- Anybody who was financially dependent on you – including if you financially supported one another – when you were alive. This may include a partner you were not married to or in a civil partnership with.
Typically, your beneficiary will receive a percentage of the income you received, and they may have to pay Income Tax on it at their marginal rate. In some cases, if the amount of pension payable is relatively small, they may receive a lump sum.
If you have a DB pension, it may be useful to check the specific details of your scheme so you understand what your beneficiaries are entitled to and how they can claim it.
Your State Pension will normally stop being paid when you die
In many cases, your State Pension payments will stop when you die, and you cannot pass them on to anybody else.
That said, there are some circumstances when a spouse or civil partner could benefit from a portion of your State Pension. This normally depends on:
- The National Insurance contributions (NICs) you both made
- When you both reached State Pension Age.
You may be able to use this government tool to check whether your partner is eligible to inherit your State Pension.
Get in touch
If you are not sure how your pension fits into your estate plan, get in touch and we can discuss your options.
Email hello@fcadvice.co.uk or call 0333 241 9900.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
