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What happens to your pension when you die? The rules about this were changed in 2015 under the Pension Freedoms. The good news is, your pensions are not usually considered to be part of your estate when you die – which means they are not subject to inheritance tax (IHT). Your surviving spouse or civil partner may also be able to access them, in certain circumstances. However, the rules depend on a range of factors including the type of pension in question and your age upon death. In this post, our team at WMM outlines how the rules work for different types of pension when someone dies.
What happens to your State Pension upon death depends mostly on your age. In 2021-22, you need at least 35 years of qualifying National Insurance Contributions (NICs) to get the full new State Pension of £179.60 per week (£9,339.20 per year). Each person has their own NI record, so broadly speaking if you or your spouse/partner dies then your/their State Pension should cease, with no further income sent to the deceased. However, in certain cases you may be able to get extra pension payments from your late spouse’s/civil partner’s pension or NICs (if you are over State Pension age and depending on whether you reached this before, or after, the 6th April 2016).
Final salary pensions
Sometimes also called “defined benefit” pensions, final salary pensions offer a guaranteed income in retirement from your past employer (e.g. the NHS). The amount you get is linked to a range of factors such as your average earnings and your years of service. If your death occurs before you retire, then the scheme typically pays out a lump sum worth 2-4 times your salary to your beneficiaries, tax-free. They also usually pay a “survivor’s pension” to the spouse or civil partner of the deceased – although this will be taxable. If you have retired and then die, however, then the scheme should keep paying out a reduced income to your spouse, partner or dependent. Consider checking the fine print from your scheme to be sure.
Defined contribution pensions
Private/personal pensions – and most workplace pensions – involve a “pot” of money, which is known as a money purchase or defined contribution pension. In 2021-22, these can be accessed from age 55 (rising to 57 in the future) and the funds can be used for different purposes, including income drawdown and buying an annuity. Here, the rules about how your pension(s) can be inherited depends on your age and how you have used the funds.
For instance, if you die before age 75 and haven’t started withdrawing funds, then your pension can be inherited by beneficiaries tax-free (provided they claim it within 2 years). If, however, you have withdrawn funds from your pension but have not spent them by the time you die, then these will form part of your estate and be subject to IHT. Whatever is left in your pension can be inherited free from tax. If you die after age 75, however, then no IHT will be due on your pension(s), but any funds withdrawn by beneficiaries will be added to their income tax bill.
Things get more complicated if you use pension funds to buy an annuity (i.e. a financial product providing a guaranteed retirement income). Some annuity types (e.g. “joint life” or “guaranteed term”) can be transferred upon death, but specific conditions may apply to the payments received by your beneficiary. These are usually chosen and stipulated at outset, such as “50% spouse pension”, and are included in the calculation of the amount of annuity you receive from day one.
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