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What Happens to My Pension When I Die?

05 January 2024
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As we diligently save for retirement, it is only natural to wonder about the legacy we leave behind and how it impacts loved ones. ‘What happens to your pension when you die?’ is a question that can become quite complex, due to various factors such as pension type, beneficiaries, and inheritance tax. Research from Netwealth has found that 88% of UK savers with workplace pensions have “at least one pension pot that remains unclaimed”, totaling on average, circa £28,000 per person. Therefore, understanding the financial impact of your pension can assure you that your earnings continue to provide for your loved ones after your passing.

In this article, we will explore:

What are the different types of pensions?

Pensions can take various forms and may depend on the employer, government policies, or your own independent financial planning choices.

In the UK, there are three significant types of pension:

Defined contribution pension

A defined contribution pension is often either a personal or stakeholder pension. It is usually a workplace pension provider that your employer organises or a self-invested personal private pension arrangement designed by yourself.

The amount you receive in your pension is determined by:

  • The amount paid in
  • How well the investment of your pension has performed
  • How you withdraw the money, such as a lump sum or regular payment

Defined benefit pension

A defined benefit pension is a type of pension plan in which the employer agrees to pay their employees a specific, predetermined amount of money upon retirement. This is measured by their salary history, amount of time in service, and a predetermined formula of the pension plan. This type of pension is more common in public sector jobs, such as:

  • Teachers
  • NHS workers
  • Emergency services (Police, firefighters)
  • Armed forces
  • Civil service

State pension

Your state pension is a regular payment made by the government once you reach the state pension age of 66 (although this age is different depending on when you were born). These payments are funded through the contributions you have made throughout your working years, as well as general tax revenue.

What is the difference between a defined benefit pension and a defined contribution pension?

The difference between a defined benefit pension and a defined contribution pension is that the defined benefit option provides a specific income, whereas a defined contribution pension depends on your pension provider, the amount you pay and the effect of the pension fund’s investment performance.

What happens to my defined benefit pension?

In your defined benefit pension, any funds that you have will be paid to your beneficiaries according to the terms and conditions of your pension plan. The amount given to your beneficiary will be the percentage of the pension you were due to receive. Your pension amount may be paid to your spouse or civil partner, your children, or a close partner that you were not married to or in a civil partnership with.

There are other factors that your beneficiaries may encounter, such as:

  • Death in service: if you die as an active employee, your dependents may receive a death in service lump sum provided by the employer. Depending on the contractual terms, it is often multiplied by your annual salary.
  • Refund of member contributions: this refers to the return of contributions made by an individual to a retirement fund or pension plan. This is usually paid when a person dies before reaching the planned retirement age.
  • Pension protection lump sum death benefit: when you start to receive a defined benefits arrangement, you can choose to guarantee a certain amount of pension payment. If you die before the guaranteed amount has been paid, the balance can be paid as a pension protection lump sum benefit.

What happens to my defined contribution pension?

Your beneficiaries can withdraw your pension in one lump sum, inherit an annuity (guaranteed income), or set up a flexible income. It is advisable to check with the pension provider to see if the scheme covers a flexible income.

Are rules regarding pensions different for state pensions vs private pensions?

The rules and regulations of state and private pensions vary significantly. The key distinctions include:

DifferencesState pensionPrivate pension
Eligibility You will need at least 10 years on your National Insurance record to qualify for a state pension Anyone is eligible to create a self-invested personal pension
Pension provider The UK Government Your choice of pension provider
Pension contribution National Insurance contributions Your choice of payment type

What happens to my pension if I die before or after age 75?

If you die before you reach age 75, any inheritance paid to your beneficiary would be tax-free. However, if you happen to pass after this age, the benefits given to your dependents may be subject to income tax. This depends on your circumstances and cannot be predetermined.

Can I withdraw my pension early as a lump sum if I have a terminal illness?

If you have been diagnosed with a serious illness, you can choose to take ill-health retirement or medical retirement if your life expectancy is predicted to be less than 12 months. This allows you to access your pension early and tax-free as a lump sum due to failing health.

Will my heirs have to pay inheritance tax on any payments from my pension?

When you die, any assets that you leave in your will (such as financial savings) will be part of your estate, and your pension is usually passed outside of this and will not be charged inheritance tax provided that certain criteria are met. However, if you choose to withdraw funds from your pension pot into your current account and not spend it all, it could be considered as part of your estate.

Discretion and Direction

A discretionary trust refers to a legal arrangement where the benefits of your pension plan are placed into a trust, and your trustees have the authority to manage how the benefits are distributed among your beneficiaries. This is organised by submitting an expression of wish form. By placing the pension benefits into a trust, the benefits pass outside your estate and so are not taken into account when calculating the Inheritance Tax of your estate.

A direction is a process of telling the distributor exactly who should benefit from your pension. The value of these benefits will be accounted for as part of your estate for inheritance tax.

Nominating dependants

Your pension provider will require you to nominate a dependant who will be the beneficiary using your expression of wish form, so ensure that you have notified your pension provider of your nominated dependant - and update it if any circumstances have changed that will impact your pension; such as the loss of a partner, marriage, divorce or the birth of a new child.

What happens to my state pension?

When you die, your state pension will typically stop being paid. However, your partner or spouse may inherit some of your pension, depending on how much your National Insurance contributions amounted to; and when you both reached state pension age. It is worth noting that it is only your spouse or civil partner who will be eligible to inherit your state pension.

Let us help you with your pension choices

We understand that discussing your pension when you pass can be a sensitive and sometimes overwhelming matter. At Culver Law, we strive to find you the solutions and financial support to contribute towards your family’s future, giving you not only options but additional advice.

Let’s work together and safeguard your future, for help and advice on your will, pension, or inheritance tax, contact us today.

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