Research shows that around 700,000 people are at risk of passing on their pension to the wrong person. It isn’t nice to think about planning for our eventual passing, but it is therefore important.
When you eventually pass on, what happens to your wealth – and in particular, your pension?
Does it go to your wife and/or children? If so, how much do they get and how does it work?
Understanding some of these issues now can help you plan ahead, possibly leaving more to your loved ones at a time when they will need a lot of support.
The rules surrounding pensions and inheritance are quite complicated. Much depends on the type of pension you have, and how old you are when you die.
Let’s take a look at how pensions fit into inheritance before suggesting some ways forward:
Inheritance & defined contribution pensions:
If you have a defined contribution pension (i.e. a scheme where you have been putting money into a pension “pot”), then your loved ones will not pay any tax on anything they receive from it as an inheritance – provided you die before the age of 75!
If you die after the age of 75, then they will have to pay income tax on any lump sum or adjustable income they receive from the pension.
What about annuities?
An annuity is a financial product you buy usually from an insurance company. In this case, you have entered a contract with them to provide you with a guaranteed income for life.
In this case, it is difficult to pass your annuity on to your spouse because the contract usually terminates upon your death.
There are ways around this, however, if you are interested in buying an annuity. One option is to buy a joint annuity – which would pay an income to a specific dependant after you die.
Or you could buy an annuity which comes with a guarantee period. This will continue paying out your annuity to a dependant during a specified period – e.g. 10 years.
Inheritance & final salary pensions
A final salary pension pays out an income to you in retirement from your employer. The amount you get usually depends on factors such as your earnings during your career, years of service and your accrual rate.
Because this type of pension does not build up a pension “pot” of money (which happens under a defined contribution scheme), passing this on to your spouse becomes difficult when you die.
Some final salary schemes will pay out a “survivor’s” or “widow’s” pension when you die, which continues to pay an income to your spouse. However, the amount and benefits they receive are usually lower than what you were getting before.
It is very rare for final salary schemes to pay out to children if both you and your spouse die. Most schemes that do so require children to be under the age of 23.
There are ways to pass on wealth to your loved ones when you die, if you have a pension like this. For instance, sometimes it is possible to replicate the benefits through life insurance.
In other cases, it makes sense for people to transfer out of their final salary scheme into a defined contribution scheme, allowing them to pass it down to their dependents when they die.
However, this is a very big decision and and it is not right for everyone. Remember, it is virtually impossible to return to your final salary scheme once you have transferred out of it.
You should consult with a professional, independent financial adviser before doing so. Indeed, the law requires you to do so anyway if you are thinking of transferring a final salary pension scheme worth over £30,000.
How to specify “who gets what”
Do not assume that your pension provider will know exactly who to pay your pension to after you die. It might not be all that clear to them, and mistakes could be made if you are not careful.
For instance, it might be that you divorced many years ago and are now remarried. Does that mean your current spouse will inherit your pension when you die? Not necessarily.
It might be that during your previous marriage, you were employed in another job and had been building up a defined contribution pension pot with them. On their paperwork, therefore, when you die the pension pot might pass to your previous spouse!
It is therefore very important that you write an “expression of will” letter, which your pension scheme administrator(s) can use to determine which dependents to pass your pension on to.
What happens to your state pension after death
You might think that you cannot pass on your State Pension after you die. This is not always the case, but how it works is a bit complicated.
The old State Pension comprises two parts. The first is your basic State Pension, and the second is any Additional State Pension you might have accrued.
Your spouse or civil partner can receive between 50-100% of your Additional State Pension as an inheritance, if you qualified for your State Pension prior to 6 April 2016. The precise amount they get depends on when you were born – the earlier your date of birth, the more they get.
If you qualified for your State Pension after 6 April 2016, however, then the rules are different. Your spouse/civil partner will inherit 50% of anything you received above the New Basic State Pension (i.e. £164.35 per week in 2018-19).