Craig Skelton and Jamie Benn explore what happens to your pension after you’ve passed away. It’s not the happiest topic but it is something that clients ask us about quite often.
On this podcast we give you some general information about what happens with different types of pension, from state pension and your defined contribution schemes.
What happens to your state pension when you’re no longer here?
The state pension is probably the most simple of them all. There are two schemes around at the moment. There’s a pre-2016 scheme and a post-2016 scheme, called the New State Pension.
Based on the old, pre-2016 scheme, if you were to pass away the old state pension will just completely cease. If you started receiving your pension before April 2016 there is no benefit paid in your name once you have gone.
The same rule applies under the new state pension, but if you’ve received a pension alongside your partner, there may be a way to top up your new state pension. Depending on how many national insurance contributions your spouse made in their lifetime, you might inherit an extra payment.
If you’re on the old scheme and you have a major life event such as losing your partner, you would find that your old state pension would be updated to the new state pension. That could also mean a slight change in premium for the better. It could at least provide a small payment, especially in households where living is a little bit tighter.
What happens to my Defined Contribution (DC) pension after I die?
A defined contribution pension is a workplace pension or an employer pension. As always, there’s not a simple answer to this. With a DC scheme what happens will be based on whether you’ve crystallised the fund or not.
In layman’s terms, crystallised means ‘done something with it’. If you’ve crystallised the fund, that means that you’ve started to take withdrawals. You might have taken your 25% tax free lump sum or done something to affect the value of that fund.
If you die with uncrystallised funds, that means you haven’t taken any payments out of your pension, be that lump sum or monthly. In that case, your beneficiaries are given quite a large amount of control over your pension.
The government decided if you pass away before the age of 75, the tax implications are positive for the family as well. So it’s worth chatting to a tax expert around that – your family might be better off from a tax point of view. They can choose to either receive the funds as a lump sum, or as a regular payment.
If a legacy has been put in place, the named survivors may be able to take a monthly income out of that pot in the future as well.
With crystallised funds, usually your beneficiaries will be given the option to receive a lump sum. Beyond that, it would depend on whether the recipient is a dependent or just classed as a member of the family. If there are no legacy rights to a DC pension it will generally be trickier to take a monthly income after the owner has passed away.
What is a defined benefit pension and what happens to that when you pass away?
A defined benefit scheme is set up by your employer. There aren’t any personal defined benefit pensions. A defined benefit pension is linked to the length of time you’ve worked for an employer and what salaries you’ve earned over the years there. It’s all described in your initial contract documents with your employer.
Defined Benefit schemes differ from place to place and have various clauses and sections as to what happens after death. What would happen to that defined benefit scheme if something were to happen to you, is outlined in that contract.
We often see variations. Sometimes the spouse will receive the full amount for a short period of time, then a reduced amount. Sometimes the spouse receives a reduced amount straight away. Sometimes a spouse or dependent isn’t included at all. So the specific details of your pension are really important.
We’ve had clients in the past where we’ve had to alter a full pension scheme because it was the right thing for them and their dependent family. It’s because they were concerned about the lifestyle they would leave the family in if they were to pass away.
So it sounds simple to say have a read through your contract, but really the best thing to do in that situation is to delve deeper. Either speak to an expert, or really take your time to explore what your spousal benefits would be. They could be the best on the market – or they could be the worst.
Either way, it will be taxable income on a defined benefit scheme unless the recipient is a non taxpayer.
How does it work with annuities?
An annuity is more of an old school investment. It might be a legacy asset that’s passed down, or it might sometimes be that an annuity really suits somebody, so they’ve decided to set one up more recently.
An annuity comes in several different forms now as the market has tried to modernise them, but the most common is still a trade system. In essence, you give the provider a lump sum, say £10,000, and they will pay you £500 a month for three years or so.
With the modern kind of annuity, you’ll find that all of the additional features are added extras, so to speak. Any options that you add to an annuity will more than likely increase the cost, which decreases the monthly payment you receive. This is where things get complicated and where it’s important to talk to an adviser who can guide you through the situation.
If I took an annuity out today, didn’t take any of those options, put a million pounds in there and die tomorrow, the million is gone. The provider may decide that a proportion of the monthly benefit might still be paid to my beneficiaries, but the actual lump sum itself dies with me because I’ve not agreed anything as part of the contract.
Even worse, if I don’t have any dependents, the monthly income is probably going to be gone as well. So it’s really important to look closely at death benefits. We would always do a joint fact find with you and your spouse to make sure that you fully understand the position that you’re going to be leaving each other in.
You might decide to have £50 less a month coming in, with the security that your partner is going to get £500 for the rest of their life if you pass away.
As with defined benefit, without a contract in front of you, I can’t say for certain what will happen – other than you need to be really clear as to what type of annuity you’re purchasing.
Is it one that is more lucrative, where they’ll offer to return some of your funds at the end? Or are you signing up for life and will never see the money you deposit again?
It’s all about making sure what you choose fits in with your life and if the worst does happen, your family is going to be okay, which is what we all worry about too.
Are there any other important things to consider on this topic?
Something to bear in mind is that divorce is another trigger point in life. We look at that as the death of a relationship rather than the death of a person. But it’s an important financial life stage.
It’s something that will be looked at from a legal aspect to help decide the fairest way to divide up any pension if necessary. You will almost only need to update your pension options on divorce.
If you have a DC scheme you might want to adapt it, or use a lump sum, especially at the point of divorce. You might need some advice to start reviewing your pensions to make sure they’re still suitable for you.