Nobody likes to think about death, but when it comes to financial matters and taking care of your family, it’s worth considering what will happen if you pass away unexpectedly. With the new pension freedoms introduced in 2015, there are more options available and more variables to consider, if we want to make sure that the right thing happens to the money you’ve worked so hard to save.
Now, we can choose to take all of our pension as a lump sum, to invest all or parts of it in other schemes, or to leave it in the scheme we originally chose. These decisions will have consequences for what happens to your pension when you die; here’s what you need to know.
Your pension choices affect the outcome
The way your pension pot is treated, and the ability of your family to receive all or some of it after your death, will depend on the options you’ve chosen for it. Your age at the time of death will also have a bearing on the outcome.
- If you have a private pension that has not been used yet
If you hold a defined contribution pension but have not taken any income from it yet, it is likely that the scheme will be paid to your beneficiaries for the full amount of your pension pot. If you pass away before you turn 75, your pot will be passed on tax free. However, if you are older than 75 when you die, the income will be taxed at your beneficiary’s marginal rate.
- If you have an annuity
An annuity is a scheme where you buy into an income for life. You buy it using the money you have saved into your pension pot over your working life. If you are receiving money from your annuity at the point when you pass away, usually it will end unless certain criteria are met. For example:
- It is a joint annuity: A joint annuity will continue to be paid to your beneficiary until they pass away. This is part of the original agreement and is guaranteed. If you are under 75 when you pass away, their income will be tax free. If you are over 75, it will be taxed.
- You are within the first 90 days: If you die within the first 90 days of your start date, value protection applies and a lump sum will be paid to your estate. However, if you have a beneficiary on your plan, no lump sum will be paid unless you both pass away during this period. Be aware that this could affect inheritance tax payable on your estate.
- You chose enhanced value protection: You can pay an additional fee when you take out your annuity to protect your income for longer. If you are within this guarantee period or value protection period when you die, a lump sum may be payable to your estate or to your beneficiary.
There are some nuances with annuities which could affect how much is paid out, who it’s paid to and whether it’s tax free or not. For this reason, make sure you understand the plan you are buying, and that you ask your provider what the outcome will be if you die.
- If you’re using a drawdown income
If you pass away while you are receiving an income from a drawdown contract, there are three potential outcomes for your pension pot.
- Before 75, your benefits can be passed on without any tax payable. Beyond 75, they can be passed on but will be taxable at the beneficiary’s rate.
- The drawdown can carry on to your beneficiary, although they’ll pay tax at their marginal rate.
- They can purchase an annuity with the remaining money in your pension pot. The income will be taxed.
You don’t need to make any decisions about this during your lifetime; indeed, it will be up to your beneficiary to make the best decision for them.
Being able to pass on portions of your pension in this way is one of the most attractive elements of the new pension freedoms. Previously, pension savings often died with the person, and if anything was passed on it was just small amounts such as joint annuity payments, which would then die with the joint policy holder.
For more information on annuities, pension freedoms and the choices you have available, talk to us or download our ‘Guide to Pension Freedoms and Retirement’.