Pensions and death benefits
One of the important benefits often associated with pension arrangements is the availability of benefits payable on or after your death. These benefits are very important as they are the means by which you can make financial provision for dependants and beneficiaries.
The benefits payable depend on the type of pension scheme that you may be in and other circumstances such as whether or not you have dependants.
Benefits may be paid in a lump sum or could be in the form of a pension payable to dependants such as your spouse, civil partner or children.
You should find out about the benefits that would be paid in the event of your death. If no benefits are payable or if these would be insufficient to provide for your dependants, then you should look at taking out life assurance cover or increasing the level of benefits payable.
The State provides a basic pension benefit to Widows, Widowers and Surviving Civil Partners.
Dependants and beneficiaries
Pension arrangements provide benefits to you when you retire. This makes you a beneficiary.
They also can provide benefits to other people in certain circumstances such as in the event of your death. These people are also beneficiaries and they are usually your spouse, civil partner or children. But the definition of beneficiaries can be broader than that. Dependants are people that are financially dependent on you. Beneficiaries don't have to be dependants.
The way benefits are paid on death depends on the type of pension arrangement you have.
For most pension arrangements, lump sums are paid into a member's estate. But for pension arrangements set up under a trust, you may be asked to nominate beneficiaries to receive the benefit. To do this you can use a document called an "Expression of Wishes", "Wishes Letter" or "Nomination Form".
The trustees will take your wishes into account but are not bound by them.
For dependants' pensions, these are paid to dependants as defined under the scheme rules and may cease as defined, for example when a child reaches a certain age.
Where pensions are payable to dependants, you need to advise your pension contact of any dependants you have; otherwise you may not be covered for the benefits you expect.
Benefits payable on death in service as a lump sum
Some pension arrangements provide lump sum benefits to beneficiaries in the event of a member’s death.
The lump sum benefits payable depend on the type of pension arrangement that you may be in and other circumstances such as whether or not you have dependants.
Example
Anne is a member of a pension scheme. Her salary is £40,000 and she is covered for a lump sum death benefit of 3 times salary. If Anne dies, a benefit of £120,000 is payable to her estate or directly to her beneficiaries.
You should find out about the benefits that would be paid in the event of your death. If no benefits are payable or if these would be insufficient to provide for your dependants, then you should look at taking out life assurance cover or increasing the level of benefits payable.
Benefits payable on death in service as a pension to dependants
Some pension arrangements provide pension benefits to dependants in the event of a member’s death in service. Typically these benefits are a percentage of salary or a percentage of the pension the member would have received at retirement.
The pension benefits payable depend on the type of pension arrangement that you may be in and other circumstances such as whether or not you have dependants.
Example
John is a member of a pension scheme. His salary is £60,000 and he is covered for a spouse's pension benefit of 1/3rd of salary. If John dies, a pension benefit of £20,000 per annum is payable to his spouse or civil partner.
You should find out about the benefits that would be paid to your dependants in the event of your death. If no benefits are payable or if these would be insufficient to provide for your dependants, then you should look at taking out life assurance cover or increasing the level of benefits payable.
Where pensions are payable to dependants, you need to advise your pension contact of any dependants you have; otherwise you may not be covered for the benefits you expect.
Benefits payable on death after retirement
Some pension arrangements provide pension benefits to dependants in the event of a member’s death after retirement. This may be determined by the rules of the pension arrangement or may be as a result of choices made by the member at retirement.
The benefits payable depend on the type of pension arrangement that you may be in and other circumstances such as whether or not you have dependants.
Example
James is a member of a pension scheme. His pension is £30,000 per annum and he is covered for a spouse's pension benefit of 50% of pension. If James dies, a pension benefit of £15,000 per annum is payable to his spouse or civil partner.
Benefits payable on death after leaving service
If a member leaves service of an employer with a future entitlement to a pension benefit, or stops paying into a personal pension arrangement or PRSA, and subsequently dies before any pension benefits become payable, then a death benefit will be paid.
The benefits payable depend on the type of pension arrangement that you may be in and other circumstances such as whether or not you have dependants.
Example
Lynne left service a number of years ago. The current value of her pension benefit under her previous employer's scheme is £150,000. If Lynne dies, this lump sum amount will be paid into her estate.
Pensions and inheritance tax
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.
Note that this only holds true if you have unspent pension pot remaining. This may not be the case if you have already bought an annuity.
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).
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 inherits 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 through 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.
How your pension might be taxed
Like any form of income, most money you take from your pension is subject to income tax. However, with careful planning you can manage your tax bill in retirement and prevent unnecessary losses.
To make sure you’re getting the most from your retirement savings, it’s important to understand how tax on pensions works, and how it could affect your retirement income.
Drawing income from your pension pot
If you have one or more workplace pensions or personal pensions, each of these will be a pot of money from which you can draw an income from the age of 55. When you do, 25 percent of what you draw out will be completely free of tax. You can do this all in one go (people call this the ‘tax-free lump sum’), or you can draw a series of smaller lump sums, with 25 percent of each being tax free).
The rest of the money you draw from your pension pots is taxed as ordinary income. Any other income you may have (e.g. the State Pension) is also included in the total. So if the total rises above your personal allowance, you will start to pay income tax – first at the basic rate and then at the higher rate, if your income is large enough in any given year.
Managing your tax bill – why you need to take care
Today’s pensions give you a lot of freedom to take the level of income you want. You can even draw out a whole pension pot as a lump sum. However, you should be very careful when doing this, and always seek advice first. This is because a large single withdrawal may result in a lot of taxable income in that year.
For example, if you have a pension pot of £100,000 and take £25,000 as your tax-free lump sum, then also take out the remaining £75,000, your taxable income will be £72,094 (if you also are receiving the full State Pension). Of this, £32,000 will be taxed at 20 per cent, and £40,094 will be taxed at 40 per cent – leading to a total tax bill of £22,437.
However, for a very small pension pot (which you might have from a short-term job), it may be possible to take the whole sum out without pushing your income too high. Alternatively, you may want to combine your pensions into a single fund. Talk to your adviser about the best course of action.
Can it make a difference how I take my pension income?
There are several different ways to draw your pension. Some of these may make it easier to manage your tax bill than others.
For example, with drawdown you can vary your annual income, so you could choose to reduce it if in a particular year your received income from another source, which might increase your tax bill.
However, if you have an annuity you will receive a fixed income every year – even if you don’t need it for whatever reason. This means that, if you were to receive additional income from another source, your annuity might result in a higher tax bill.
Whether or not these issues affect you will depend on your lifestyle in retirement.
Is there any other pension tax I should know about?
Income from your pension can be subject to an additional tax charge if your pension has grown very large, and so exceeded the lifetime allowance.
Making the most of your financial adviser.
Here are five ways you can make the most of having a financial pro on your side, and understand how to best use a financial planner so they can maximize the value they provide to you.
1. Be open, honest, and coachable
This should go without saying, but a financial planner cannot help you if you don't share openly with them. That means disclosing all the details of your financial life — and I know that can be really difficult to do.
But remember, your planner isn't here to judge you (or shouldn't be; this is why it's really important to do a gut check to make sure you actually like and trust your planner before hiring them).
Your planner should create a safe place for you to lay everything out on the table. Together, you need to understand where things stand now in order to make the best comprehensive plan for moving forward and getting to where you want to go with your financial life.
In addition to sharing the numbers, share your thoughts, goals, fears, and worries, too.
Personal finance is personal; money is much more emotional than purely analytical. How you feel about your finances will impact your behaviour and your actions, so sharing openly with your planner will help them design a strategy you will implement.
There are probably a lot of routes and options that will eventually get you to where you want to go. The best one is the one you'll actually stick with over time.
Finally, you also want to be coachable. That means being:
Open to feedback (and also open to change, based on that feedback)
Willing to take action once you have a strategy in hand
Ready to ask questions
Interested in learning
The best financial planner in the world won't do you a bit of good if you're not willing to change or consider new things in the process of reaching your goals.
2. Accept the accountability your planner can provide
Knowing what to do is one thing — and your financial planner can certainly tell you the right things to do with your money to make the most of it and build wealth over time.
But how many times have you started a diet or exercise program because you knew that's what you needed to do to gain muscle or lose weight… only to find you fell off the wagon less than two weeks into your new routine?
Knowledge typically isn't enough when it comes to behaviour change, updating habits, and making progress toward long-term goals that could take months or years to achieve.
To best use a financial planner, definitely take advantage of the knowledge, advice, and wisdom they can give you… but make sure you lean on them for the accountability piece, too.
Your planner should assign you action items or tasks to take after each meeting in order to move forward.
These could be really tangible, like "increase your contribution to your pension plan," or "transfer that extra cash from your current account to a short-term savings goal or a long-term investment account."
Or they could be really intangible, like "talk with your partner about your priorities and be ready to share at our next meeting," and "think through what you would like to do next: buy a house or start a business."
In either case, your planner should also follow up with the accountability to make sure you get this done. Just like a personal trainer holds you accountable to getting in the gym and doing the reps, a planner can send reminders, check in with you between meetings, and make sure things don't slip through the cracks as you make progress with your plan.
3. Listen, especially when they advise against something
Most people are focused on what a planner will tell them to do to reach their goals. But one of the most valuable things you can get from a relationship with a financial planner is listening to them when they tell you not to do something.
When you get panicky and want to sell out of your positions in your investment that you set up for long-term wealth building? Listen when your adviser says, "let's sit tight and stick to the strategy we designed before you felt emotional about this."
When you feel pressured to buy a home because your local market is hot? Listen when your adviser says, "I understand you don't want to miss out, but the plan we built has you buying a home in 5 years. Let's keep working on building up the deposit you need to buy the house you want."
Your adviser can help you stay focused, disciplined, and consistent with the actions you need to take — and avoid — on your way to building wealth.
4. Ask for referrals to other professionals who can go to bat for you
You probably worked really hard to find a financial planner you trust, like, and enjoy working with — and repeating this process for every professional you need on your team sounds a little overwhelming, doesn't it?
Thankfully, you can just ask your adviser for referrals and recommendations.
Most planners have a professional network because they know that's a huge value-add to provide to their clients.
So when you need a solicitor or an accountant, ask your financial adviser for a referral to someone they know.
5. Uncover your blind spots
What we know typically falls into two categories:
The stuff we know we know
The stuff we know we don't know
These two areas are pretty easy to manage. When we know things, we can use that knowledge to our advantage. If we know that we do not know other things, we can choose to learn or ask questions to get the answers we need from experts who do have a particular domain knowledge.
Where we can get into trouble, however, is with a third category of knowledge:
The stuff we don't know we don't know.
In other words, we can get into trouble with our blind spots. When we don't know we don't know something, we don't have the questions to ask. We don't know what we need to learn.
The blind spots aren't the problem. It's not asking someone to check them for you that will cause issues. This is where your financial planner can come in.
They can provide an objective, outside perspective on your finances and your financial plan to look for those things you didn't even know to check or ask about.
Together, they can work with you to eliminate blind spots and shore up your defences against the unknown.