What happens to my pension fund if I die?
My answer to this question was published by thisismoney.co.uk today and you can read this in full here.
The precise answer will always depend on your individual circumstances and objectives, but here is what I had to say on the subject:
The death benefits from a pension plan will vary depending on whether you have started to take retirement benefits and also how you have structured the plan.
Assuming you die before you retire, in most cases the entire value of your pension fund can be paid to your beneficiaries free of tax. This is a valuable death benefit that is often overlooked when planning for family financial protection.
Because the majority of pension plans are written in trust as default, the value of the fund should be kept outside of your estate for inheritance tax purposes.
This means that it can be paid free of tax and quite promptly. To speed things up and ensure tax efficiency, you should make sure that you have completed a ‘nomination form’ for your pension provider, explaining precisely who you want to receive benefits and what proportion they should receive.
If you have any protected rights funds within your pension, a type of pension fund built up to replace your entitlement to a State Second Pension (S2P), then these are treated slightly differently.
Because these benefits are supposed to replicate those you would have received from the State, on death this part of the fund has to provide an income to your spouse, civil partner or financial dependents, in the form of an annuity or unsecured pension.
Some older types of pension will, in the event of death before retirement, return the total contributions plus interest, rather than the fund value. This can result in your beneficiaries receiving substantially less than they could have received if the pension plan had been restructured before death.
How to avoid inheritance tax
A common mistake made with pension funds is for the pension plan holder to nominate their spouse or civil partner to receive the value of the pension fund.
From an inheritance tax planning perspective, this simply aggravates the tax position when the partner dies as the value of the pension fund is included within their taxable estate.
A simple solution to avoid this problem is to establish 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.
What happens if I die during retirement, then?
The death benefits available from a pension fund after retirement will depend to a large extent on the retirement income option selected. If you buy an annuity with your pension fund, you can build into the annuity a death benefit in the form of ongoing income for your partner or other beneficiaries.
This can be costly, so you need to balance the importance of a death benefit from an annuity with the costs involved.
If you select an unsecured pension, leaving your pension fund invested and drawing an income directly from the fund, then the death benefit options are more flexible.
Your beneficiaries can, for example, choose to receive your entire pension fund as cash less a 35% tax charge. Alternatively, they can continue to receive an income using unsecured pension or use the entire pension fund to buy an annuity.
With some pension funds worth a substantial amount of money, planning for the available death benefits is an important part of overall retirement planning and something you should take seriously.
Speak to an independent financial adviser to discuss the various options and to ensure that your own pension plans are structured in the more efficient way should the worst happen.