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Saving for retirement is a fantastic discipline that you want to be rewarded for during your lifetime, but many of my clients always ask “What happens to my pension when I die?” Does your pension go to a former employer, the state or a life insurance company instead of your loved ones? It might do, but that depends on the options you take at and in retirement. So let’s look at how to ensure your loved ones receive your pension fund.
What Happens to My Pension If I Die Before Retirement?
Generally speaking, with almost all pensions from both companies you worked for and personal pensions you set up, the value of the pension will be paid to your dependents or beneficiaries tax free. The only exception here is the State Pension, which will then be lost. So if you were to pass away prior to retirement, there is less to be initially concerned about. Be sure that you have completed a ‘Nomination of Beneficiaries Form’ for your pension though, so the trustees will know who you want your funds to go to, as your Will won’t influence this money. If you want to avoid it being lost from the family, you might also want to consider using a Trust to protect this money, but more on that another time.
What Happens to My Pension If I Die After Retirement?
What happens to your pension after retirement depends on the choices you made at retirement, so we need to look at each in turn.
If your pension was saved up as part of a company ‘Money Purchase’ or ‘Final Salary Pension’, and at retirement you chose to take that income, then your spouse is likely to get around 50% of that income on your death in most, but not all, cases. You will need to check the scheme rules to be sure. If you don’t have a spouse at the point of death, and your children have already flown the nest, then your former employer will keep the money, and your loved ones won’t get any of it.
If you have a Personal Pension, either set up by you or by a company that had a Group Personal Pension, you will have had choices at retirement. These choices will determine what happens on your death. The main choices would have been:
1. Purchase an Annuity. If you purchased an annuity; i.e. bought a fixed income for the rest of your life, at the point of purchase you will have had to decide if you wanted a spouse’s pension and any guarantees. It will be those choices that determine if anything is left after you die to anyone other than the life insurance company that sold you the annuity. In most cases this may mean your spouse gets some income, but, after that, the money will be lost.
2. Used Income Drawdown. If you resisted the urge to buy an annuity, and left the money in the pension to draw the income gradually, in what is commonly known as Income Drawdown, and now Flexi-Access Drawdown, then the good news is there are options. Generally speaking, the money will pass to your nominated beneficiaries, possibly minus some tax. There is more on this subject in the article ‘What Happens to My Drawdown Pension Fund When I Die’ as it is a little more complicated.
So you can see, the choices at retirement determine what happens to your pension when you die. If leaving the money to your family is important, you either need to purchase an annuity that facilitates this or you need to use ‘Drawdown’.
As an example, Captain Black, who has worked at British Airways all of his life, and, as a result, has a very sizeable Final Salary Pension Scheme that promises him an income of £70,000 per annum. Rather than take this, British Airways will offer the alternative of transferring £2m to a personal scheme of his choice, where he can draw the income as he likes. If he draws this as income from the scheme, and his wife and he die at 3 years into retirement, they may have had around £210,000 out of the scheme. The rest of the funds will be handed back to British Airways, not their family. If however he transferred that benefit to a Personal Pension before he reached retirement, his children would be inheriting the remaining £1,790,000. As you can see, his choices make quite a difference to his loved ones.
There are many factors to consider when making your choices at retirement, and the death benefits are one of those factors. I strongly urge you to seek Independent Financial Advice to ensure you make an informed decision.
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