What happens to my pension when I die?

Defined Benefit (DB) pension death benefits

In the past, many people could join a ‘final salary’ or ‘salary-related’ pension scheme. Under this sort of pension arrangement there is a pension promise (a ‘defined benefit’) that you will get a certain amount, a bit like a salary but less, depending on how long you were in the pension and how much you earned. These types of pensions are still available in the public sector but not usually in the private sector. You might have a mix of defined benefit and defined contribution pensions.

• If you die after you have started to receive a DB pension, a surviving spouse, partner, children under 23 (older if disabled) will normally receive a percentage of your pension until they die.
• If you die before you reach pension age the pension scheme may pay a lump sum benefit to a nominated recipient.

It’s important that the benefits from the scheme are paid out in line with your wishes so it’s important to keep expression of wish (also known as nomination of beneficiary) forms up to date.

Defined Contribution (DC) pension death benefits

Most pensions now are ‘Defined Contribution’. This can mean workplace pensions, private pensions or SIPP’s. These are all examples of defined contribution pensions. You build up a pot of money when you are working and then you make choices about what to do with that pot of money in retirement. There is no guarantee that this will last until you die.

• If you have taken your pot of money and turned it into an income for life (called an ‘annuity’) then whether there is anything for your beneficiaries depends on the sort of annuity that you’ve bought. If you bought a ‘joint life’ annuity then when the first person named on the policy dies, a regular payment will continue to be made to the second person. If you bought a ‘single life’ annuity then in general the payments stop on your death, though some policies have a guarantee period where payments continue for a minimum period of time (e.g. for the first five years after retirement).
• If you still have money in your DC pension pot, perhaps you are still working, or if you have moved money into ‘drawdown’ account, any money left in the pot or drawdown can be passed onto to family, friends, a charity or a trust.

How can beneficiaries take money out of a Defined Contribution pension?

There are 3 ways in which your beneficiaries can normally take money out of defined contribution pension; cash, drawdown and annuity purchase.

• Cash. Take the whole amount out as cash.
• Drawdown. Move the money into drawdown. This means that the money is still invested but they can take money out of this as and when they want to or it can be left in the drawdown fund. When someone has their own pension pot they have to be 55 or over (rising to 57 in 2028) to move their money into drawdown but if it has been passed on from someone who has died, there is no age restriction. So, a 5 year old could have a drawdown fund and money could be accessed for them.
• Annuity. They could buy an annuity which would give them a regular, guaranteed income until they died.

Who can receive your pension death benefits in a Defined Contribution pension?

Benefits don’t have to be paid out to just one person, a number of people could benefit.

It's really important that you fill in an expression of wish or nomination form so that the pension company know who you’d like to receive your pension death benefits.

You might want to just put your husband or wife’s name on the form but it’s also a good idea to write down the names of others too. That’s in case your husband or wife doesn’t need the money and would prefer that it’s passed onto your children or others. If the children are over 23 and not dependant on you then not having their name on the form could mean that they would have to take all the money out as cash which could mean a lot of income tax is payable. You can write something like this though “I’d like my husband to receive my pension death benefits but if he isn’t alive or doesn’t want them, I’d like my children Jane and Fred to receive them.” This means that you are saying who your preference is for but at the same time, making sure that your children’s names are on the form.

Will my beneficiaries pay tax on my pensions when I die?

For income tax, it depends on when you die and the type of pension you have. For inheritance tax, in general, pensions are not included in a person’s estate.

When it comes to income tax the rules are:

Defined contribution

Before age 75. If you die before the age of 75 and leave money in a defined contribution pension pot or in drawdown, your beneficiaries don’t have to pay income tax on the money they withdraw unless the lump sum and death benefit allowance has been exceeded. This limits the amount of tax-free lump sum that can be paid both in lifetime and on death. It is set at £1,073,100. Anything paid as a lump sum above the available lump sum and death benefit allowance is taxed at the beneficiary’s marginal rates of income tax. We recommend you speak to a financial adviser for information if you think this applies to you.

Age 75 or over. If you die at age 75 or over, your beneficiaries have to pay tax at their highest marginal income tax rate on any money they withdraw.

Defined benefit

Any age. If your spouse, partner or children receive a regular pension from a defined benefit scheme then it’s subject to income tax. It doesn’t matter what age you are when you die.

What happens to your State Pension when you die?

The answer to this question depends on if you reached State Pension age before or after 6 April 2016. But these rules only apply to husbands or wives and not cohabitees, who aren’t entitled to anything.

'Old’ state pension system – you reached pension age before 6 April 2016

For the basic state pension, if your spouse is not getting a full basic pension they can make a claim on the basis of your National Insurance record. For example, a widow could get a full state pension based on her late husband’s National Insurance contribution record.

For any Additional State Pension, generally 50% of is inheritable by your husband or wife. However, a higher percentage can be passed on if the man was born before 6 October 1945 and the woman born before 6 July 1950 and more information can be found here.

Your spouse can’t inherit your Additional State Pension if they remarried or formed a civil partnership before they reach State Pension age.

‘New’ state pension system – you reached pension age on or after 6 April 2016

The State Pension system is now based around individuals rather than couples. This means that your husband or wife can’t make a claim based on your National Insurance record.

If you built up more than full amount of State Pension this is called the "protected payment". Half of this "protected  payment" can be passed onto your husband or wife. For example, you might receive an extra £20 a week over the maximum State Pension. That would mean your husband or wife would receive an extra £10 a week on your death.