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What happens to your private pension when you die?

They say two things are certain in life – death and taxes. Of course, we may begrudgingly pay the taxman his due, but you must ask, “what happens to your private pension when you die?”

Two most common types of private pension?•Defined contribution pensions
•Defined benefit pensions
Factors that affect private pension taxation when you die?•Death age of pension holder
•Uncrystallised pension
•Type of pension withdrawal
What is the main factor that affects defined benefit pensions when you die?If the pension holder retired prior to death
The most important State Pension rule when you die?If the pension holder reached State Pension age

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Budgeting for your retirement could be taxing unless you use suitable tax wrappers, such as ISAs or SIPPs. In this blog, as well as explaining what happens to a private pension when you die, we also explain why you should seek professional advice regarding how much you can leave your loved ones. To find out more, please read on.

Various types of pensions

As you are probably aware, there are several types of pension schemes. They include:

  • The State Pension
  • Defined contribution pensions
  • Final salary pensions
  • Private pensions
  • Workplace pensions

Different conditions apply to each type of pension when it comes to the rules and regulations concerning inheritance tax and pension beneficiaries. In some instances, the age at which you pass away can have an effect. In this blog, we focus on private pensions, and if you’re asking yourself, what happens to my private pension when I die? – all will be explained in due course.

A frequently asked question is “If my husband dies, do I get his private pension”?

This is a question that concerns many married women or women in partnerships. However, the answer is more complex than you might hope because who gets your private pension when you die is determined by several factors. Please read on for a fuller explanation.

The two most common types of private pension

There are two common types of private pensions, and each behaves differently in terms of what happens if you die before you begin receiving payments from them.

Defined contribution pensions

A defined contribution pension scheme is a scheme that relies on how much has been paid into it either by you and/or your employer. In other words, it relates to a defined amount. This type of pension is also termed the “money purchase’ pension scheme.” What happens to your private pension when you die is that the pension fund from your defined contribution pension can be taken out as a lump sum, invested in a drawdown or used to buy an annuity.

How you choose to receive the income from your pension will impact the action your beneficiaries should take. For example, if you took a lump sum from your pension but had some cash in your bank account separate from your pension, this will be considered part of your estate.

Also, your age of death will affect the tax treatment of your pension when passed down to your beneficiary.

Defined benefit pensions

What happens to a private pension when you die, and your pension is a defined benefits scheme? This scenario is a little different because this type of pension is linked to your salary and for how long you worked for your employer. The main consideration with these types of pensions is whether or not you retired before you passed.

If you pass away before you retire, the private pension payments after death will be based on between two to four times your salary. Any beneficiary payments will be tax-free if your death occurs before you reach 75.

This type of pension also reimburses what is termed a “survivor’s pension” to the spouse, partner, or dependent child. However, these payments will be taxed at the dependent’s marginal rate of income tax.

Should you die before you reach retirement, defined benefit pensions will continue to pay a reduced pension to spouses, civil servants, or any other dependents. The rules that apply to the scheme in question will define who can be regarded as a dependent.

However, compared to personal pensions, these rules are considerably stricter when determining who can receive death benefits.

Unfortunately, not everybody can afford a private pension. Thousands of people still rely on the State Pension and are concerned about what happens to their pensions after their death. So we will round off this blog with a brief explanation.

Moneyfarm does not offer defined benefit pensions. However, defined contribution pension plans, such as SIPPs, are available.

What happens to defined contribution pensions when I die?

Upon your death, there are a variety of ways to withdraw funds from pension accounts. The tax implications of your pension vary according to your age at death and if your beneficiaries don’t make a claim within two years of your passing. Here are the options below

What happens to my uncrystallised private pension when I die?

An uncrystallised private pension is a retirement fund that has not yet been withdrawn from through drawdown or converted into an annuity.

If you haven’t withdrawn any income from the scheme, what happens to the private pension when you die before reaching the age of 75, is that it can be passed on to your beneficiaries tax-free. The money can be withdrawn as a lump sum payment, an annuity, or a flexible retirement income (pension drawdown).

If you die after age 75, your beneficiaries will have to pay tax based on their marginal income tax band. However, please note that the inherited amount can move you into a higher tax bracket.

What happens to my annuity private pension when I die?

With an annuity, the situation is a little more complex. If you have already begun taking income from an annuity prior to your death, the scheme cannot be passed on to a beneficiary under normal circumstances. However, certain kinds of annuity can be passed on after death, and these include joint life, value-protected, and guaranteed term annuity schemes.

If the annuity in question is one of those mentioned above, your beneficiaries can receive future payments free of tax; however, certain factors could apply. In this case, what happens to a private pension when someone dies is that although your beneficiaries can receive future payments free of tax, specific conditions may have to be observed. Your best bet is to seek advice from your pension provider or a wealth specialist company.

What happens to my drawdown private pension when I die?

With flexi-access drawdowns or pension drawdowns, you can access your pension savings, and you can take out up to 25% tax free. The advantage of a flexi-access drawdown is that your pension funds remain invested while having access to it.

If you took the drawdown option, what happens to your private pension when you die before age 75 is that your beneficiaries can access the remaining money in your pension fund completely tax-free. The remainder can be taken in drawdown payments or as a lump sum, or used to purchase an annuity.

However, if you die after age 75 with a pension drawdown, your beneficiaries have to pay income tax on payments or income received from your pension pot. The tax paid will be based on their marginal rate of income tax, which can become higher due to the inherited pension fund.

What about inheritance tax?

Pension drawdowns are free from IHT as it does not form part of an estate. However, assets such as cash, savings and investments from money withdrawn from a pension before death are considered part of your estate and are liable to Inheritance Tax. Pensions outside of an estate are often not subject to Inheritance Tax.

The main residence nil rate band threshold of £175,000, and an estate valued at up to £325,000 is exempt from taxation, giving each person a total allowance of £500,000. Tax-free allowance could go up to £650,000 if a spouse or civil partner did not use their £325,000 threshold. That means that married couples can leave behind £1 million inheritance tax-free. Inheritance Tax is charged at 40% on any part of your estate that exceeds the threshold limit, including any gifts given in the seven years leading up to death.

What other pension inheritance tax rules apply?

As stated above, what happens to your private pension when you die before the age of 75 is that your defined contribution pension fund is untaxed. Suppose you die before age 75, any uncrystallised pension fund is tested against your lifetime allowance at death and none after that.  However, if you were on an annuity or flexible retirement plan, your pension would have been tested against your lifetime allowance at account setup before age 75.

The lifetime allowance is currently set at £1,073,100. Tax is paid on the amount above the lifetime allowance. If you die after age 75, your pension is not tested against the lifetime allowance. However, any pension inherited will not count towards your beneficiary’s lifetime allowance.

Get in touch with your pension provider or scheme trustees if you don’t know what benefits your loved ones will get after your passing. They can explain the details of your plan and how it affects your beneficiaries.

Information about SIPPs

SIPPs are Self-Invested Personal Pension schemes that allow you to choose how to invest your savings. They are a form of defined contribution personal pensions. The value of your pension pot when you reach retirement age is dependent on the contributions made into the pension, as well as the performance of the investments.

The rules for the disbursement of pension funds essentially follow those described above in relation to defined contribution plans.

Regarding inheritance tax, the proceeds from SIPPs don’t form part of your estate when it comes to inheritance tax, provided they remain uncrystallised at the time of your passing. If you took out the 25% tax-free lump sum and transferred it into your bank account, it would form part of your estate from an inheritance tax viewpoint.

In April 2015, new SIPP inheritance tax rules came into force. They reduced the tax liability regarding any lump sums paid to beneficiaries when the policyholder died after 75, from 45% to the recipient’s marginal income tax rate.

What happens to your state pension after you die?

You now know who gets your private pension when you die, but what about your State Pension? The good news is that you can pass your State Pension payments on after your death. However, they can only go to your spouse or civil partner.

The most important rule regarding the State Pension and the death of the pension holder is whether or not he or she was of pensionable age before the last changes came into effect on the 6th of April 2016.

If you were of pensionable age before the 6th of April 2016 and you were receiving the basic state pension, then your spouse or civil partner will be able to claim your additional State Pension. The decision and the amount of additional state pension your wife or partner could receive will be dependent on your National Insurance contribution details.

In certain cases, a lump sum could be passed on upon death, with your spouse or partner qualifying for bereavement benefits.

Should you have reached state pension age after the 6th of April 2016, your spouse or partner could be entitled to inherit an extra payment in addition to your pension.

There is another scenario you can take into consideration. Suppose your husband, wife or civil partner reached pensionable age before the 1st of April 2015, and your National Insurance record is better than theirs after your demise. In that case, your partner can request his or her payment to be calculated on your record and not theirs.

Your wife or civil partner may also be able to inherit a part of your additional state pension – if you paid into one, that is.

Seek financial advice

We hope this blog has answered your question about what happens to my private pension if I die in a way you understand. The good news is that in most instances, your pension pot can be passed on to your dependents and, in some cases, tax-free.

However, it is quite a complex subject, so if you are left in any doubt, we recommend you talk to your pension provider or an independent wealth specialist advisor.

FAQ

Who receives your pension when you die?

The pension beneficiaries are determined by the terms of the pension contract and the specifics of that contract. Pension beneficiaries can be spouses, civil partners, children, or grandchildren.

What taxes do you pay on the private pension you inherit in the UK?

The taxes you pay on inheritance will depend on the type of pension scheme, payment plan, and the age of the deceased pension owner. For example, up to 45% income tax is charged on defined contribution pensions with lump sums or annuity payments, and if the pension owner dies at age 75 or over. Also, if the deceased’s pension is above the current lifetime allowance, you will pay a lifetime allowance tax charge. Visit gov.uk for more information.

How does inheritance tax on pension work?

Inheritance tax is imposed on a deceased’s estates (property, money and possessions), but it usually does not apply to inherited pension pots. This is because pensions are usually ‘discretionary‘, so pensions are not considered part of a deceased estate. However, inheritance tax is charged if pension payments are not discretionary. As standard practice, a 40% inheritance tax applies to part of an inherited estate over £325,000 that is not left to a spouse, civil partner, or charity.

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*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.