What happens to your private pension when you die?

Planning for what happens to your pension after you pass away is a key part of managing your finances. In this article, we’ll explain the essentials – from how Defined Contribution and Defined Benefit pensions differ, to what role Inheritance Tax plays, and the important age of 75.

What happens to Defined Benefit (DB) Pensions?

A DB pension pays an income in retirement based on your salary and how long you worked for your employer. This can be calculated using final salary or career average, depending on scheme rules.

The rules of each scheme are different, but your pension administrator will usually pay a ‘dependant’s pension’ to your spouse/civil partner or someone who is financially dependent on you. There are conditions that apply, and the eligibility criteria can vary between schemes.

The income will be a percentage of the pension you were getting or due to get, usually 50%, and will be taxed at the beneficiaries’ usual rate of income tax.

There are also certain rules that allow lump sums to be taken by beneficiaries from a DB pension, but this varies from scheme to scheme.

What happens to Defined Contribution (DC) Pensions?

A DC pension can be viewed as a pot of money whose value is based on how much you and your employer paid into the scheme and investment growth.

Your DC pension may be paid in different ways, depending on the type of pension you have and the pension scheme.

• Lump sum: The entire pension pot can be paid out at once to your beneficiaries.
• Flexi-access drawdown: Funds remain invested, allowing your beneficiaries to withdraw money over time.
• Annuity: Beneficiaries may use the funds to purchase an annuity, providing a guaranteed income.

If an annuity had already been purchased with the pension funds, on death the benefits your beneficiaries will receive depends on the options you chose when this was set up.

Age 75 & the Two-Year rule

Inherited pension funds are taxed depending on the age at which the pension holder passes.

• If you die before age 75: The funds your beneficiaries receive can often be taken tax-free.
• If you die after age 75: Your beneficiaries will pay income tax at their usual rate on withdrawals.

To preserve the under 75 tax advantages, pension providers must distribute benefits within two years of being notified of death. If they take longer, the tax benefits may be lost.

What you should know about pension death benefits

 Lump Sum and Death Benefit Allowance (LSDBA)

The LSDBA limits the total tax-free lump sums that can be paid on your death. This includes lump sums paid from pension savings, Death in Service benefits, and certain serious ill-health provisions. Any amount above this limit may be subject to income tax when received by beneficiaries. The current allowance is £1,073,100.

 Expression of Wish

Private pensions allow you to complete an Expression of Wish form to nominate who you would like to receive your pension. This is separate from your Will.

You can nominate almost anyone as your pension beneficiary, such as a spouse, partner, child or even a friend. While the pension provider may have the final say on who it goes to, they should take your wishes into account.

If you don’t nominate anyone, your pension could go to your estate. This could cause delays and create unnecessary tax complications. Therefore, it is important to make sure your nominations are in place and up to date.

Inheritance Tax

At present, pensions usually fall outside of your estate for inheritance tax purposes, which means your beneficiaries can receive the funds free of inheritance tax.

However, the government has published draft legislation which proposes that, from April 2027, unused pension funds and pension death benefits will be included in your estate on your death and therefore subject to inheritance tax.

State Pension

State Pension will generally stop being paid once you die, although in some cases, your spouse or civil partner may be able to claim part of it. This is based on their own entitlement, and when you both reached state pension age.

The Value of Professional Advice

Pension death benefits can be complex, with different rules for various types of pensions, changing tax legislation, and personal family circumstances to consider. A Financial Planner can help you understand your options, keep nominations up to date, and structure your pensions in the most tax-efficient way for your loved ones. This ensures your wishes are carried out smoothly, and that your beneficiaries receive the maximum possible benefit.

If you are looking to discuss your pension death benefits, our financial advisors can assist.

Contact us on 0330 320 9280, email info@cravenstreetwealth.com or complete our online enquiry form for practical advice tailored to your own circumstances and needs.

 

The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice. References to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of publication. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments. You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.