YOU might think that if you’ve written a will, then all your money will automatically go to your chosen loved ones when you die.
But when it comes to pensions – often one of the biggest assets people have – the money has its own set of complicated rules.
When you die, most things you own form your “estate”, which is covered by your will. But pensions don’t form part of your estate, so you need to do extra planning to make sure they go to the right place.
The good news is that this also means some forms of pension can be passed on entirely inheritance tax-free, up to a limit of over a million pounds, as inheritance tax typically only covers your estate.
However, it also means that you need to understand the rules for the different kinds of pensions and make sure you have filled in the relevant paperwork for each one.
The Sun spoke to three pensions experts to find out everything you need to know.
Defined contribution pensions
Defined contribution (DC) pensions – sometimes also known as private or workplace pensions – are one of the most common forms of retirement savings in the UK today.
With this sort of pension, you save money into a “pot”, and you get tax relief on top.
If it’s a workplace auto-enrolment scheme, your employer will also pay in some money on your behalf. The minimum contribution you can make is 5%, while your employer must pay at least 3%.
This money is invested, which means that cumulative interest helps it to grow throughout your working life.
This can be one of the most tax-efficient ways to leave money to loved ones, so it’s important to consider this when you’re thinking about how – and when – you start drawing your pension.
The tax rules depend on how old you are when you die, what kind of pension pot you have, and whether the pension has been accessed.
If you’re under the age of 75 and have not accessed your pension, then your loved ones will receive the benefits tax-free – up to a limit of £1,073,100.
They can typically choose to take this money as a lump sum, put the cash into a flexible drawdown scheme, or buy an annuity (a fixed income for life).
Any pension savings above that limit will be taxed as ordinary income at the beneficiary’s marginal tax rate.
If you’re over 75 when you die, then your loved ones will have to pay income tax.
If they take the money as one big lump sum, then this could mean a big tax bill, but if they choose to use flexi-acess drawdown and only withdraw smaller amounts each year, this can reduce tax by spreading the payments.
No inheritance tax is paid on DC pensions that have not been accessed.
If you’ve withdrawn money from your pension
If you have taken money out of your pension – either as a tax-free lump sum or as ordinary withdrawals to fund retirement, then that money is classed as part of your estate and will be subject to inheritance tax.
Whereas money still left in the pension is exempt.
So, taking big sums of money from your pension if you don’t need them can leave you with a hefty income tax bill that you wouldn’t have if you’d spread the money – and can also mean less cash to leave to your loved ones tax-free.
How do I consolidate my pension?
IF you have several workplace pensions that you're no longer paying into, you might be better off consolidating them into a single pot.
There are several advantages to this.
The first is that by having your savings all in one place, you’ll only pay one set of fees.
You can also choose which pension provider you want to transfer the different savings to, so you can pick the best one for you.
It also makes it easier to keep track of your money.
You might want to move all your money to whichever of your existing pots has the best fees, or you could move it all to your current employer pension (if you have one).
Alternatively, you may wish to move money to a private pension or use a consolidator service, such as Pension Bee, Aviva, or Wealthify.
Make sure you compare and contrast your options carefully so that you’re picking the best home for your savings.
You’ll need to look at fees but also might want to consider the investment options available.
If any of your pots are over £30,000 you’ll need to get independent financial advice, but even if you have lots of smaller pots you should consider speaking to an independent financial advisor (IFA).
You can use Unbiased or VouchedFor to find a recommended advisor near you.
Also ask whether you’ll be charged a fee to exit your existing provider and to join your new provider, plus whether the age at which you can access your pension is different – for most people this is currently 55, but is set to rise to 57.
You also need to ensure the pension you’re leaving doesn’t come with valuable added perks, or you could lose out.
Stay alert for pension transfer scams as fraudsters often target people transferring their pension with promises of investments that are too good to be true.
If you’ve bought an annuity
If you’ve already retired and you chose to buy an annuity with your pension, the inheritance rules are different and your dependents may get nothing at all.
What – if anything – your loved ones will get depends on what kind of annuity you bought.
Clare Moffat, pensions expert at Royal London, explained: “If you paid for a guarantee period which is often five or 10 years, then this means an agreed amount of money will be paid out if you die during that time.
“If you bought a joint-life annuity and you die first, then your partner will normally receive a percentage of the payment you previously received.
“If you bought a single life annuity, then there is no money payable on death.”
How to make sure your DC pot goes to the right person
Our experts caution that to make sure the money goes to the right people, it’s critical to fill out an expression of wish form.
Because pensions are not considered part of your estate, they’re not governed by what’s in your will.
Robert Cochran, workplace savings engagement and innovation specialist at Scottish Widows, said: “It is important to make sure you fill in what pension companies call a “nomination of beneficiaries form” – this lets them know who you want the money to go to on death – it could be anyone you choose and may even be a charity.
“If you don’t fill one in, then the pension company has to follow complex rules, and this will have two effects – one, the process will take much longer, and two, your fund might not go to the people you want to get it.”
He added that most modern providers let you fill in or update these forms online with just a few clicks of a button, adding that with Scottish Widows, the process takes just one or two minutes on average.
If your circumstances change, you can usually just log in and update the forms.
The other thing to remember is that you need to keep these forms updated for every private pension you have, including workplace schemes and any Self-Invested Personal Pensions (Sipps).
One thing to watch out for is thinking you’ve already done this because:
- you have a will
- you have “death in service” cover at work
Both life cover and wills are separate, and so what you put on them will not impact where your pensions go.
Ms Moffat added that if the forms are filled in correctly, then your loved ones will get the pension much more quickly, and without having to go through probate.
She said: “Inheritance tax doesn’t apply, and, more importantly for many, your loved ones won’t have to wait until your estate is sorted out before it is paid.
“However, the pension company must investigate who you’d like to receive the pension.
“If you’ve filled in an up-to-date beneficiary nomination form, then it’s much easier for them to know who you’d want to give the money to.
“If you hadn’t filled in a form, then the pension company would still investigate to find out who should receive the funds.”
She added that it’s important to update your beneficiary nomination forms for any pensions with previous employers, too.
“The more planning that you can do now means the less stress, uncertainty and heartache your family members may face at an already painful and difficult time,” she said.
You might have filled the form in when you started work but may not have thought about it again. It’s a good idea to put anyone you might want to be named as a beneficiary to receive the money on the form.
Steve Webb, former pensions minister and partner at pension consultants LCP, cautioned that even if you have filled in the form, the scheme can decide to pay the money elsewhere if there is a good reason.
He explained: “Although a member can say who they would like the money to go to after their death, this is generally not binding on the trustees.
“There is a good reason for this – for example, suppose you nominate a first wife/husband and then divorce and remarry but forget to update your paperwork.
“Trustees have the discretion to award the survivor’s pension to your second husband/wife, as this is probably what you would have wanted, even though the paperwork says something different.
“Of course, trustees should not simply ignore the wishes of the member, but they may take other factors into account.”
Defined Benefit pensions
Defined Benefit (DB) pensions are sometimes also known as final salary or career average salary pensions.
These are where you get a guaranteed income for life after you die, rather than having a pot of money to spend.
They used to be popular in the private sector but have now been mostly replaced with DC pensions.
However, they’re still very common in the public sector, such as government jobs, teaching, the NHS and the army.
They’re often considered to be gold-plated pensions because instead of relying on what you contribute and how much your money grows, your employer agrees to pay you a guaranteed income throughout retirement, which is based on what you were earning while you were employed.
Often the income will rise in line with inflation, which means your money keeps pace with cost-of-living increases.
If you have a DB pension, what happens when you die will be outlined in your scheme’s rules, so it’s important to check this as it can vary from scheme to scheme.
It’s fairly common for some of the pension to be paid to dependents, who’ll usually get a percentage of what you would have received if you had lived. But there are usually limitations on who counts as a dependent and the money will be subject to income tax.
Ms Moffat said: “On your death, a percentage of your pension will be paid to a surviving partner and typically any children under 23.
“There might be a lump sum payable if you die before retirement and you can fill in a form to say who you’d like to receive it.
And Mr Webb added: “The level of the ‘survivor’s’ pension will often be 50% of the pension the person who died was receiving, but it could be different to this depending on the rules of the scheme.
“Where a couple were living together but not married, the exact rules will vary from scheme to scheme. Often a ‘survivor’s pension’ can be paid to a nominated (unmarried) partner, subject to certain restrictions.”
The state pension
The rules around state pensions and inheritance are highly complicated.
Government website Gov.uk says that you may be able to get extra pension payments from your husband, wife or civil partner’s pension or National Insurance contributions.
However, what can be passed on depends on whether the deceased or the spouse is under the old state pension or the new one and when they died.
If you reached the state pension age before April 6, 2016, you should be able to get any State Pension based on your husband, wife or civil partner’s National Insurance contribution when you claim your own pension.
You will not get it if you remarry or form a new civil partnership before you reach State Pension age.
If you reached State Pension age on or after April 6, 2016, you’ll receive the “new State Pension” and you may be able to inherit an extra payment on top of your pension if your spouse or civil partner dies.
Mr Webb said: “An important point is that there is no inheritance right for partners under state pensions unless there is a spouse or civil partner – a person who cohabited outside marriage has no rights at all to inherit state pension from their late partner.”
You can contact the Pension Service to check what you can claim.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) – This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension – The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won’t be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension – This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you’ll be paid a set amount each year upon retiring. It’s often referred to as a gold-plated pension or a defined benefit (DB) pension. But they’re not typically offered by employers anymore.
- New state pension – This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you’ll need 35 years of National Insurance contributions to get this. You also need at least ten years’ worth to qualify for anything at all.
- Basic state pension – If you reach the state pension age on or before April 2016, you’ll get the basic state pension. The full amount is £156.20 per week and you’ll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what’s known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.
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