What happens to your pension when you die?
If you’ve made a will, well done. But the job’s not quite finished yet. Many people don’t realise that wills don’t cover pension pots – so you need to make separate arrangements. Chartered Financial Planner Carl Roberts explains.
They say you can’t take it with you. And in an ideal world, many of us would like our pension to last exactly as long as we do, so we can spend every hard-earned penny before (as they also say) ‘checking out’. But of course, life often doesn’t go as planned.
Until fairly recently, you would probably have been obliged to buy an annuity (a guaranteed income for life), and this annuity would die with you, unless you chose a costlier joint life annuity that also covered your spouse (in which case, it would cease upon your spouse’s death). But all this changed a few years ago, when pension freedom allowed people more control over their pension pots. It’s now possible to keep your pension pot invested and to draw an income from it throughout your retirement, in a variety of different ways.
In other words, if you have a money purchase pension (which is an actual pot of money as opposed to a guaranteed income), there may still be some of it left at the point when you die. So what becomes of this money – and what do your beneficiaries need to know about it?
Inheriting a pension pot
It’s an interesting question – and one that most people overlook. Many believe that if they have a valid will in place, then all arrangements regarding inheritance and beneficiaries are taken care of. But what you may not realise is that your will only covers your estate – and your pension does not technically form part of your estate, but is dealt with entirely separately. Therefore, whatever is written in your will does not have any effect on what happens to your pension.
To specify who inherits your pension (there can be more than one beneficiary) you will need to make separate arrangements with the pension provider. If you have several pension providers, you will have to do this with each of them. You can read more about how to do this in the section below.
The actual treatment of a pension pot depends on whether you die before or after reaching the age of 75. If you die younger than 75, then whoever inherits your pension can choose to take out all of the money in one lump sum, or keep it invested in the pension fund and draw out money as required. There is no inheritance tax (IHT) to pay and also no income tax on the beneficiary.
If you die after 75, the only difference is that your beneficiary or beneficiaries will have to pay income tax at their marginal rate on withdrawals from the pension. There is still no IHT to pay.
This separate treatment of pensions has made them a very useful planning tool when it comes to reducing IHT. For example, you might choose to conserve your pension for as long as possible and live off other assets (which would be subject to IHT), so as to reduce the size of your taxable estate and maximise your family’s inheritance. Similarly, this may encourage you to pay more into your pension in advance of retirement, since this has the added advantage of sheltering that money from IHT.
How to choose what happens to your pension when you die
Once again: your will does not cover your pension, so you’ll need to make separate arrangements with your pension provider(s). Everyone with a money purchase pension should follow this simple to-do list:
1. Make sure you keep a record all of your pensions, their current value and the details of each provider. Keep this updated on a regular basis so your family can easily locate all your pensions if necessary.
2. Contact each provider and ask for a ‘nomination of beneficiaries’ form or an ‘expression of wish’ form (different providers may have different names for this).
3. Using this form you can specify whom you would like to benefit from your pension. It doesn’t have to be one person, so if you like you can split it between a few different people, such as your partner and children.
4. Keep a copy of the form and send the original back to the pension providers.
5. It’s vital to keep the forms under regular review, as circumstances change.
Point 5 is particularly important. You don’t want to end up like the client of mine who, when we were reviewing his pension, found out that his ex-wife was still nominated to receive his pension death benefits!
Please note that all of the above applies only to money purchase pensions (also known as defined contribution pensions). If you have a final salary (also known as defined benefit) pension, the rules are far more restrictive. There is no ‘pension pot’ to inherit, and quite often it is only married partners who can receive pension death benefits. However, ever scheme is different, so it is best to check with the scheme administrator, or ask your adviser to do so on your behalf.
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Carl Roberts APFS is a Chartered Financial Planner at Wealth and Tax Management and the Managing Director of RTS Financial Planning.