Maximising Your Pension Legacy: Understanding the Options Available to Your Beneficiaries
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. You should always seek professional advice from an appropriately qualified adviser.
All contents are based on our understanding of current legislation, which is subject to change, any information provided here is only correct at the time of posting.
There is a risk to your capital and you may not get back the full amount invested. The value of investments, as well as the income from them, can fall as well as rise.
When you pass away, your pension doesn't necessarily die with you. Instead, it can provide financial security for your loved ones. However, the way in which your pension is handled after death depends on various factors, including the type of pension plan you have and the choices you made during your lifetime. In this blog post, we will explore what happens to your pension when you die, the different ways in which it can be paid to your beneficiaries, and how these payments may be taxed. Additionally, we'll discuss the pros and cons of each option. It’s important to remember that the specific options available will depend on your pension plan and its rules.
What Happens to Your Pension When You Die?
The fate of your pension after you die depends on the type of pension you hold:
1. Defined Benefit Pension (AKA Final Salary Pension): Typically, these pensions provide a guaranteed income for life based on your salary and years of service. Upon death, a portion of your pension, often 50%, may be paid to your spouse or dependents as a regular income. The death benefit options are confirmed by the scheme and very little flexibility exists with this type of plan.
2. Defined Contribution Pension: With this type of pension, your retirement pot is built up from contributions and investment returns. What happens to this pot when you die depends on the options available with your plan/provider and can range from a lump-sum death benefit to securing a guaranteed or flexible income in your retirement.
In both cases, understanding the options for passing on your pension is crucial for ensuring your beneficiaries are financially secure. This blog post will focus on defined contribution pension options given the number of options available.
Different Ways in Which a Pension Can Be Paid to Beneficiaries
There are several ways in which a defined contribution pension can be passed on to your beneficiaries. These options include:
1. Annuity
An annuity is a financial product that converts your pension pot into a guaranteed income for life or a fixed term. If you purchased a joint-life annuity or an annuity with a guaranteed period, payments may continue to your beneficiaries after your death.
If you are yet to make a decision on your defined contribution pension and no money has been taken from the pension when you die, this option also exists for your beneficiaries, allowing them to set up a guaranteed income with the proceeds.
Tax Implications: If you die before the age of 75, the income from an annuity can usually be paid tax-free to your beneficiaries. However, if you die after 75, the income will be taxed as income for your beneficiaries.
Pros:
- Guarantees a steady income for beneficiaries.
- Provides financial security, especially for spouses.
- Removes investment risk and potential depletion of funds.
- Cons:
- Lack of flexibility once the annuity is purchased.
- Payments may stop after the annuity period ends or after the beneficiary’s death.
2. Dependents/Nominee Flexi-Access Drawdown
Flexi-access drawdown allows your pension pot to remain invested while your beneficiaries withdraw funds as needed, either as regular income or lump sums.
Tax Implications: Similar to an annuity, if you die before age 75, withdrawals made by your beneficiaries will typically be tax-free. If you die after 75, withdrawals will be taxed as income for the beneficiary.
Pros:
- Offers flexibility in how and when beneficiaries access the funds.
- Potential for the pension pot to continue growing if investments perform well.
Cons:
- No guaranteed income, which could lead to financial uncertainty for beneficiaries.
- Investment risk remains; the pension pot could decrease in value over time.
3. Lump-Sum Payment
Your pension can also be paid out as a lump-sum payment to your beneficiaries. This option provides immediate access to the entire pension pot.
Tax Implications: As with the other options, if you die before age 75, the lump sum will be paid tax-free. If you die after 75, the lump sum will be subject to income tax at the beneficiary's marginal rate.
Pros:
- Immediate access to funds, which can be helpful in meeting urgent financial needs.
- No ongoing management or investment risk.
Cons
Receiving a large sum at once may lead to poor financial management or depletion of the funds too quickly.
May result in a significant tax bill if the lump sum is taxable.
Considerations for Choosing the Best Option
The right option for your beneficiaries depends on their financial needs and circumstances. For example, a spouse or dependent who requires a steady income may benefit from an annuity, while a financially savvy beneficiary might prefer the flexibility of a drawdown. It's also important to consider the tax implications and ensure your beneficiaries understand how any inherited pension will be taxed.
Summary: The Importance of Planning Ahead
When planning your estate, it's crucial to consider what will happen to your pension when you die. The options available to your beneficiaries—annuity, flexi-access drawdown, or lump-sum payment—each have unique advantages and disadvantages, and the tax treatment will depend on your age at death.
Remember, the specific options available to your beneficiaries will depend on the type of pension plan you have and the rules governing it. Therefore, it's essential to review your pension arrangements regularly and discuss your wishes with your pension provider to ensure that your loved ones are taken care of after you're gone.
While not covered in this blog post, it is important to consider the total value of your pension benefits and the lump-sum allowance and lump-sum and death benefit allowance which may limit the amount that can be paid tax-free to your beneficiaries. This is a complex area of pension and retirement planning and we recommend you speak to a suitably qualified adviser to help you understand where you expect to sit against these death benefit tests.
Proper planning and clear communication with your beneficiaries will help them navigate this difficult time and make the most of the financial support your pension can provide.