Pensions and inheritance
What happens to your pension when you die? 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.
This only holds true if you haven’t yet used your pension pot to purchase an annuity. An annuity is a guaranteed income for life (rather than a pot of money) so can’t be passed on as such. If you want your partner to continue receiving an income from your annuity after your death, you’ll need to choose an annuity which offers this extra benefit.
Similarly, 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.
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.
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?
If your estate is large enough to be potentially subject to inheritance tax, you may be able to use your pension to reduce or even eliminate your inheritance tax bill.
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. 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.
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