There is a change coming in the near future with a date set that could put an end to passing on your benefits
When it comes to managing pensions, the focus is generally on how much you will receive, how best to manage your private pensions as you progress towards retirement age, and how you’ll draw from your state and private pensions when the time comes.
What isn’t so commonly discussed is what happens to those pensions in the event of your death.
They are indeed something that can be passed on, whether you’ve begun to draw from them or not, but it’s important to understand how this can work, what the differences are between the different types of pension, and how you can get things in order so your wishes are fulfilled once you’re no longer here.
What happens to your state pension after you die?
The state pension is paid out to individuals aged 66 or over who have made at least 10 years of National Insurance (NI) contributions, with the full amount being made available to those who have paid 35 years’ worth of NI contributions. When you reach pension age, you can choose to defer your payments and so receive larger ones at a later date.
Generally speaking, your state pension stops when you die and can’t be passed on.
There are a few caveats, however, depending on whether you’re eligible for the Additional State Pension, your spouse’s NI contributions, and whether you deferred your pension payouts upon reaching the state pension age.
For those not familiar, the Additional State Pension is paid out on top of the regular pension to men born before April 6, 1951, and to women born before April 6, 1953.
There are a few scenarios to consider here:
You pass away before reaching the state pension age – in this instance, your spouse or civil partner may gain additional pension benefits if they also haven’t yet reached the pension age
You pass away after reaching the state pension age – if you received the Additional State Pension, and you’re on the pre-2016 system, your partner may be able to inherit part of that upon your passing.
If you’re on the post-2016 system, they may be entitled to increased pension payouts.
If you deferred your state pension and hadn’t begun to draw from it before your death – your spouse or civil partner may be eligible for either a lump sum payment or increased payments on their own pension.
As a rule of thumb, however, the state pension typically ends upon your death and cannot be claimed by your spouse or civil partner. This is because the state pension is tied to your own NI contributions and so it’s not eligible for tying to another individual.
What happens to private pensions when you die?
Private pensions work very differently, and in many instances can be passed on to a beneficiary or beneficiaries in the event of your death. There are two kinds of workplace pensions, however, and it’s important to understand what they are, how they work, and how passing them on can differ.
“Workplace pensions come in two main types: defined contribution (DC) and defined benefit (DB),” explains Fiona Peake, personal finance expert at Ocean Finance. “With a DC pension, it’s all about the pot of money you’ve built up. If you pass away before age 75, your beneficiaries can usually access this money tax-free, as long as it’s paid out within two years. After 75, they’ll likely need to pay income tax on any withdrawals at their own rate.”
An important element here is in whether beneficiaries have been nominated.
If they have, either by informing your pension provider or by naming beneficiaries in your will, they will typically receive your DC pension under the conditions Peake has explained.
In cases where no beneficiary has been named, the pension provider may decide where it goes on your behalf and it will typically be endowed to your estate. Under these circumstances, the funds would be eligible for inheritance tax, depending on the total value of your estate.
If you’ve already begun drawing your private pension, the ways it can be passed on will be affected by how you decided to access it.
If you chose a drawdown option, in which the bulk of your money remains invested while you withdraw what you need, anything remaining in your fund can usually be inherited by a beneficiary.
“Lump sum payments or setting up an income for beneficiaries are both common options,” says Peake.
For those who opt for annuities, however, the terms can be more limiting.
“If you’ve bought an annuity with your pension, it’s important to check the terms,” Peake continues. “A basic annuity stops paying out when you die, but if you’ve got a joint or guaranteed term annuity, there might be payments that continue to your spouse, partner, or dependants.”
That’s defined contribution pensions covered, but what about defined benefits pensions?
DB pensions, sometimes known as final salary pensions, provide a continued, guaranteed income rather than a money pot from which to draw. “When you pass away, some schemes might pay a percentage of this income to your spouse, partner, or dependants,” explains Peake. “The exact rules depend on the scheme, so it’s worth checking with your provider to see what applies.”
If you have a DB pension in place but your spouse or civil partner is not listed with it, it will typically stop upon death unless that particular scheme allows for continued payments to your children or other dependants. Regardless of the type of private pension you have, it’s important to name your beneficiaries and keep that information up to date.
“One area where people can sometimes lose out is forgetting to nominate a beneficiary for their pension,” says Peake. “Most workplace pensions let you name who you’d like to benefit from your pension when you die, and it’s something you can usually update if your circumstances change. For example, if you’ve divorced or remarried, you might want to revisit this to make sure it reflects your wishes.”
Looking forward
It’s important to remember that, as with the state pension age, many rules around pensions, how they’re paid out, and how they can be passed on are not set in stone. In fact, what’s true of pensions now is already set for a major, tax-focused change from April 2027 as Joshua White, Head of Growth at Level, explains.
“From April 2027, the rules around pensions and inheritance tax will change significantly, as most unused pension funds will be included in the value of an estate for inheritance tax purposes, removing a previous exemption,” he says. “This shift will particularly impact individuals on defined benefit schemes, though it’s less of a concern for those on defined contribution pensions.
White continues with the broader tax implications of this change, particularly where ‘fiscal drag’ – the phenomenon by which frozen tax thresholds pull more people into the tax system via wage inflation – is concerned.
“Given current property prices and fiscal drag, we at Level estimate that around one million UK properties currently just below the inheritance tax threshold could become liable due to these changes. As property is often the main asset in an estate, this will bring many estates into the scope of inheritance tax for the first time.
“It’s clear from HMRC’s consultation notes that this change is designed to prevent pensions from being used as a tax-planning tool rather than a means of providing for retirement. Executors and beneficiaries need to be aware of the potential tax implications and plan accordingly.”
It’s important to be abreast of upcoming changes and how they will impact upon your situation.
If you’re ever in doubt or need further guidance, it’s never too late to get in touch with a financial adviser or pensions expert to assist with understanding your own circumstances, your options, and how you can pass on your pension when the time comes.
