It’s not something that most people like to think about. And with life expectancy getting longer, it seems the conversation about what happens to your pension after you die can be put off for a long time.
But it is important to prepare because doing nothing could leave a lot of loose ends for loved ones to untie. Not only that but making smart decisions now can also mean leaving them with private pension payments after death so you know they’re well-provided for.
Of course, the options are almost as varied as the pensions market itself. When choosing a scheme, it’s a good idea to put in place a plan for what happens when you die, to ensure the most straightforward transition of funds to those you leave behind.
There are more things to think about than most people realise, and different outcomes depending on the age of the pension holder when they die. But within your control are decisions to be made about how much tax liability your loved ones will be left with or spared; what type of income or lump sum they will draw; and how long a policy lasts after your death.
The apparent complexity of the options available is another reason people might put off making the big decisions. But it’s important that they do.
We’ve put together a brief overview of the main things to be thinking about. For any more questions or for more detailed advice, you can always talk to one of our pensions experts.
Pension annuity or drawdown?
It’s essential to first understand the difference between an annuity pension and a drawdown, or flexi-drawdown, both for the time you are drawing your pension, and to know what happens to your pension after you die.
The key difference between the two is that while an annuity provides a fixed income to the holder each month no matter what, a drawdown gives you various options. These include taking a lump sum straight out of the money you have saved up, or taking an income, which the holder is able to vary as they choose.
Likewise, there are important differences between the two in the event of the death of the policy holder. A lot of this depends on when that occurs (see below), but there are important distinctions at any stage of the process.
When you decide to retire, you must make a decision about what to do with your pension pot â take out an annuity or take a drawdown. Usually, at this stage, most people leave instructions as to what will happen when they die.
Leaving behind an annuity
Unless you have a joint annuity, payments stop as soon as you die. This means you can nominate a named person, usually a spouse or partner, to transfer the policy to. So the person will go on receiving an income after you die. Tax treatment varies according to individual circumstances and is subject to change.
There are other options, such as one similar to the above, but with payments to a nominated person only lasting for a fixed period. Another variable is the amount the policy pays out. You can arrange for this to increase over time under some schemes. Once again, tax treatment varies according to individual circumstances and is subject to change.
We explore this topic further in our guide: What Happens To Pension Annuities After Death?
Leaving behind a drawdown
The drawdown also enables you to provide a more flexible income for your loved ones when you die. This, however, comes with certain risks which you must be aware of.
You can choose to allow a nominated person to immediately claim the remainder of what is in a drawdown as a lump sum, essentially transferring the policy over to them. Likewise, that person can also then draw an income from the fund, or draw a partial income while leaving the bulk alone to be invested as shares.
The age factor
Your age is an important factor in what happens to your pension when you die. Remember too that tax treatment varies according to individual circumstances and is subject to change.
If a person dies before they reach 75, the nominated beneficiaries generally receive whatever lump sums or incomes they are bequeathed as they are left them at the time. If the holder dies past that age, those funds are generally taxable.
What happens to the remainder of a policy can be decided years beforehand by the holder, for each eventuality: their death occurring before they reach the age of 75 or after.
If they have elected to leave their pension to a loved one or loved ones in a single lump sum, this will be received tax-free if the holder dies before they reach 75, and subject to some (varying) tax levels afterwards. If the holder has chosen to leave their money to a fund of any kind, this will be subject to 45% if they die at 75 years or older.
Again, in the case of annuity or drawdown pension policies, the level of payouts to those bequeathed by the holder depend on the age.
The beneficiary of a drawdown pension will draw any earnings from it tax-free in the event of death before 75 â or as part of their taxable income after that age. The rules for annuities are very similar: monthly payments become part of the beneficiary’s taxable income if the policy holder lives past 75.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested