Everybody starts pension schemes on the assumption they’ll be around to spend the money in retirement. And thanks to rising life expectancy, most of us will, but not everybody. What happens if you take out a pension and actually do fall under a bus? Who does your pension pot go to then?
With the retirement age rising to 68 by 2046, more of us could die before our pension pays out, and we should all plan ahead, just in case
What happens partly depends on what type of scheme – or schemes – you have
Final salary schemes, also called defined benefit schemes, are, sadly, not as prevalent as they used to be
If you die before drawing your pension, most schemes will pay up to a maximum two-thirds of the likely pension you would have got if you had worked with the company until retirement. Many will also pay a death-in-service benefit to a maximum of four times your annual salary. There may also be separate dependants’ pensions paid to each child up to the age of 18 or 21
These payments can go to your husband, wife, any dependent children, or nominated beneficiaries.
Schemes do vary. Some companies pay a pension to unmarried partners and same-sex partners, or even other relatives. Others may not, so check the rules carefully
Most employees are now in money purchase, or defined contribution, pension schemes, and will use their pot to buy an annuity at retirement age. But what if you don’t make it that far?
Your scheme should return the value of your fund at time of death, including employer contributions, tax relief and any growth. Some employers may also offer death-in-service benefits as well. If you have money-purchase benefits with a previous employer you should also get a full return of your fund
Stakeholder and personal pensions
Once again, you get your money back, or rather your survivors do, in the form of a lump sum known as “return of fund”. This will include all your contributions, tax relief and any growth. The same goes for members of group personal pensions
If you’re single, your state pension dies with you. If you’re married, and your partner is over 45, they may be able to claim a £2,000 refund lump sum, then the full basic state pension for up to 52 weeks
When they reach state pension age, their basic state pension may be topped up to a maximum £90.70 a week, which is the full state pension for a single person, depending on your contributions. They may also claim 50% of any second state pension (S2P) entitlements you had.
But if you’re simply cohabiting, your partner won’t get a penny. This spells disaster for couples who have lived together for years, only for the main breadwinner to die before retirement
There are some things you should do, regardless of the type of pension you have. When you take out a scheme, you should make an expression of wish, setting out your beneficiaries. You should also regularly check your nomination is up to date, particularly if you have divorced or remarried, to make sure the money goes to the right person
You should also consider writing your plan into trust, setting out exactly who you want to get the money. If you don’t, any payout could end up being decided by probate, which could take months
And you should also write a will (and keep it updated), to make sure your wishes are clear and legally enforceable
Sorting out your pensions and other assets are particularly important for unmarried partners, who have no legal protection when it comes to divvying up the goods
This is particularly bad news for women, many of whom wrongly assume they are entitled to their partner’s assets as a ‘common-law wife’ –- there’s no such thing — or because they have lived with their partner for a certain number of years
The truth is that even if you have children together, your legal entitlement is zero. If you want to be sure your pension and other assets will go to an unmarried partner you must either nominate them or set this out in your will. And again, don’t forget to update those nominations
The pension can be paid as a lump sum and a 55% tax charge will apply. Alternatively a surviving spouse or dependant can use the pension to provide a taxable income for themselves. If the pension is used to provide income then the 55% tax charge does not apply, however, any income will be taxed at their normal income tax rate. If you are not survived by a spouse or dependant, your fund can be paid as a lump sum to charity without any tax charge
What if I’ve started to take my pension?
It depends on whether you’ve taken an annuity or have opted for income drawdown
The following options have to be chosen when you set up your annuity and will affect the level of income you receive. Once your annuity’s being paid it can’t usually be amended
Spouse’s pension: The income will continue to be paid to your spouse or partner after your death, for the rest of their lifetime. You must specify the percentage of your income you wish them to receive
Guarantee period: 5 and 10 year guarantee periods are usually available. If you die within the guarantee period the annuity will continue to be paid as income for the remaining period. Some providers will allow these payments to be made outside your estate
Value protection: Some annuity providers offer a ‘money back’ option known as value protection. If you die before a pre-agreed age the insurer will pay back the annuity purchase price, less the taxable income you have taken already and less a 55% tax charge
No options chosen: A basic single life annuity ends on your death
Income drawdown or flexible drawdown
You’re not required to decide your options at the outset. The two main options are:
A lump sum payment: Your pension can be passed to the person you nominated to receive it as a lump sum subject to a 55% tax charge
Continuing to take an income: If your beneficiary is your spouse or dependent they can choose to use the pension fund to buy an annuity or to draw it as drawdown. The 55% tax charge is not applied but any income will be taxed at their normal income tax rate
Death benefits from pensions are not normally subject to inheritance tax. Lump sums in excess of the lifetime allowance (£1.8 million in 2011/12 and £1.5 million in 2012/13) could be subject to a tax charge
Note. however, that if a lump sum is paid, for example to your surviving spouse, then that sum becomes part of their estate and could be subject to Inheritance tax when they die. There are ways around this outside of ordinary IHT planning, specifically something called a spousal by-pass trust, so the cash is available to the partner during their lifetime but remains outside of their estate for tax purposes. For this, as for all matters relating to pensions and IHT, take professional advice as necessary