What happens to your pension when you die?
It's a key question that sadly has become much more pressing in recent months, due to the coronavirus crisis.
This article explains which parts of your pension can be inherited by your family, and also what can't be.
The good news is that your family can inherit any remaining money in your pension pot that you haven’t yet spent or converted to an annuity. This makes your pension a very tax-efficient way to pass on your wealth – and one that you can even use to reduce inheritance tax (IHT) on the rest of your estate.
Can my family inherit my pension?
When you die, any unspent money in your pension pot can be passed on to one or more beneficiaries of your choice. This assumes you have a defined contribution (money purchase) pension scheme, which is the case for most workplace pensions and all private pensions.
What happens to my annuity when I die?
An annuity is a guaranteed income for life (rather than a pot of money) – and by definition, an income for life ends when your life ends. This means it can’t be passed on as such. However, you can arrange for your partner to continue receiving an income from your annuity after your death. To do this, you’ll need to choose a ‘joint-life annuity’.
You could of course choose to spend only part of your pension pot on an annuity. In this case, the unspent portion will be inheritable as normal.
What happens to my final salary pension if I die?
If you have a defined benefit (final salary) pension, there is no pension pot to pass on. However, the terms of your scheme may make provision for your spouse and/or other dependants. Ask your scheme administrator what will happen in the event of your death. Alternatively, some final salary schemes let you transfer out into a defined contribution pension, which you can pass on to your family. A transfer may not be the best option for you, though, so ask your financial adviser.
What happens to my SIPP when I die?
If you have a personal pension, such as a SIPP or a stakeholder pension, this can be passed on to your beneficiaries just as a workplace (defined contribution) pension can be. You just need to make sure you follow the necessary steps laid out below under ‘How do I choose who inherits my pension?’
What happens to my state pension when I die?
In most cases, payment of your state pension will stop completely when you die, and does not pass to your spouse. However, there are a few circumstances in which your spouse will continue to receive a portion of your state pension after your death.
If you have the Additional State Pension
Before the current ‘new state pension’, the state pension consisted of two parts: basic and additional. If you reached state pension age before 6 April 2016, you may have built up some additional state pension. If you married before 6 April 2016, your spouse can inherit a portion of this when you die.
Similarly, you can inherit some of your spouse’s additional state pension if they reached state pension age before this date (or if they would have reached it on or after that date, but have died).
Any inherited additional state pension is paid with the surviving spouse’s state pension.
If you have a protected payment
Some people may have a ‘protected payment’, if they built up more state pension than the maximum amount of the new state pension before it was introduced (to avoid them losing out under the new scheme). If your basic state pension plus additional state pension would have entitled you to more money than the new state pension alone, then this excess is your ‘protected payment’.
If you married before 6 April 2016, your spouse will inherit half of your protected payment (and vice versa).
You can estimate how much annual income you could expect in retirement using our pension calculator here.
How do I choose who inherits my pension?
Your pension isn’t legally part of your estate, so is not covered by your Will. You have to make arrangements with your pension provider by filling in a form – this may be called an ‘expression of wish’ form or a ‘nomination of beneficiaries’ form, or something similar.
The crucial thing is to make sure that these arrangements are kept up to date. Usually you will complete an expression of wish form when you join a pension scheme. If you’ve had several pension schemes over your working life, then the beneficiaries you’ve nominated may be different in each case – for instance, an ex-spouse or partner, rather than your current one.
You should therefore make an effort to track down your pensions and update your wishes with each provider. It may make more sense to combine your pensions – however check with your adviser first, to make sure you don’t lose any special benefits like guaranteed annuity rates.
Also keep your will up to date. Though it doesn’t directly cover your pensions, it can help to resolve any disputes that may arise.
It will then be up to your chosen beneficiaries to contact your pension scheme provider(s) after your death, to find out how they can claim your remaining pension benefits.
Quick tips for bequeathing your pension
1. Keep records of your pensions and tell your family where to find them.
2. Contact pension providers to check who is due to inherit your pension, and update the details if necessary.
3. Keep a copy of all paperwork.
4. Be sure to review all pensions if your relationships change.
5. Combine your pension pots if your adviser recommends it.
Is my pension subject to inheritance tax?
Pension pots are not subject to inheritance tax when you die. If you die before the age of 75, the person(s) who inherit your pension pot can draw on the money as they wish, without paying any income tax either. However, if you are 75 or over when you die, a beneficiary of your pension pot will have to pay income tax on any withdrawals at their marginal rate (i.e. the highest rate of income tax that they pay).
If your beneficiary is entitled to continue receiving payments from an annuity or defined benefit pension after your death, then these payments will be subject to income tax at their marginal rate.
Can I use my pension to reduce inheritance tax?
Since pension pots fall outside your estate and are not taxed upon your death, you could potentially move savings and investments (which are taxable) into your pension pot by making additional contributions. This has the added advantage of increasing your pension pot and boosting your savings though tax relief on pension contributions. If you do this, however, be careful to stay within your pension allowances (your annual allowance reduces after you start to draw your pension).
Another option is simply to spend other assets first and preserve your pension for as long as possible, or until your estate is below the IHT threshold.
To find out more about pensions or inheritance tax, talk to a financial adviser.