Passing Pensions On - Following Death in Retirement

October 2019
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Pensions are designed to provide an income for life of the plan owner, this can start at any time after age 55. What happens to the pension on the death of the retiree depends upon the type of scheme, the options chosen at retirement and whether the owner dies before or after age 75. This guide explains what usually happens on death in retirement for each type of pension plan.

Types of pension scheme

  1. Final Salary or Defined Benefit Schemes, most common in the public sector, these schemes are sponsored by an employer, with trustees appointed to manage the scheme within a trust deed and scheme rules. Scheme rules determine the basis of the scheme pension payable for life and what happens after the scheme member dies.

    This often includes an ongoing regular scheme pension for a dependent spouse or civil partner, usually at a reduced level, say 50%, of the member’s pension.

    If there are dependent children, it may pay a pension to them until they cease education or reach age 23. Other financial dependents may or may not receive anything.

    The definition of eligible spouse or civil partner may also be restricted, if for example, someone has married after retiring or if a spouse is considerably younger than the member. Civil partners may not gain rights to a pension earned before 2005. To find out what is available, the trust deed and scheme rules must be consulted as they are unique to each scheme.

    Lump sum death benefits are usually only payable from this type of scheme if the member dies very soon after drawing the pension, when the balance of the first 5 years’ pension may be paid as a lump sum.
     
  2. Employer sponsored occupational money purchase schemes and group personal pensions. Like final salary schemes, these schemes are sponsored by an employer and usually arranged under a trust, but they do not promise a guaranteed lifetime income. Instead they produce a pension pot as do personal pensions, SIPPs and stakeholder plans. The member can exchange their pot at retirement to secure a lifetime guaranteed income from an insurance company, called an annuity.

    They also have the option of transferring their pot into a drawdown plan, from which they may take regular or one-off withdrawals until the fund is exhausted. The options on death of the pension plan owner are described in 3 and 4 below and are determined by the choices made by the individual with their pot.
     
  3. Guaranteed Lifetime Income (a lifetime annuity). What happens after the death of the annuity owner depends on the options they choose when buying it. It‘s possible to include an ongoing income for a dependant’s lifetime, this can be  the same as the plan owner’s income, or a lower amount.

    The income can be guaranteed for a minimum period, payable even if the owner dies before then, with named persons designated to receive it. If paid at the administrator’s discretion, this does not form part of the estate but If the nomination is binding it does.

    The plan can pay out a lump sum on death, if the total of income payments received at the date of death has not equalled the total purchase price, this is called value protection. Adding these options means that the lifetime income is less than it would be without them. The reductions are not significant and enable the ongoing income to be designed around dependants’ needs. Considering all options, prior to buying an annuity, is advisable as it cannot be altered later.
     
  4. Flexi-access drawdown introduced in 2015. Pension pots can be invested in a flexi-access drawdown plan at retirement, which then allows the owner to withdraw funds when they choose. On death of the plan owner, the drawdown plan can be passed to others. They may choose to remain invested, buy an annuity or drawn down from the fund.

    Plan owners should make their wishes known in a nomination form. This should be updated if circumstances change. A major benefit of passing on a flexi-access drawdown plan is that the fund pays no income tax or capital gains tax while it is invested and is outside of the member’s or beneficiary’s estate for inheritance tax purposes. Until all funds are drawn out, the plan may be passed on to several generations in this way.

Taxation

Pension plans and pension incomes inherited from others are not usually subject to inheritance tax and do not count towards the recipient’s own Lifetime Allowance (£1,055,000) for pension savings. Otherwise the tax treatment is as shown below, with age at death before or after age 75 being significant. 

Age at death

Scheme pension

Annuity income

Flexible drawdown

Under 75

Income taxable

Income tax free

Income tax free

 

 

 

Fund growth tax free

Over 75

Income taxable

Income taxable

Income taxable

 

 

 

Fund growth tax free


Kay Ingram
Director of Public Policy, LEBC

Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. The contents of this blog are for information purposes only and do not constitute individual advice. A pension is a long-term investment. The fund value may fluctuate and can go down. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. If you are unsure of the suitability of any investment or product for your circumstances, please contact an adviser. All information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation, are subject to change. Taxation advice is not regulated by the Financial Conduct Authority.

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